Author Topic: Is a Roth IRA the right choice at this time for my Family?  (Read 5664 times)

jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Is a Roth IRA the right choice at this time for my Family?
« on: October 04, 2017, 11:00:56 PM »
My wife and I have been debating back and forth on what type of IRA we should open for here.  I think a Roth would be the best fit, she would like to go with a traditional for the tax break.   Any arguments for either would be appreciated as we try to break this stalemate.

Our stats.  Me 33, DW 31, 3 kids 10,5, and 2.  We live in California.  Currently making $49,000 gross, but with the kids and allowed deductions we pay zero taxes.  Only deductions are SS, Medicare and CA SDI.     After everything is said and done(emergency fund, no debts except a mortgage)  we have $9,000 a year for investing.   This year we maxed out a Trad. IRA for myself for the first time and are trying to figure out the best place to put the remaining $3,500.

Work doesn't have a 401K,  there is a 457 plan, but no match and lowest expense on a fund is 3%,  so I'm thinking that wouldn't be a good option.  I feel Roth would be the best option as we aren't going to be paying any taxes for the next few years as my income starts to grow over the next 5 years, however once the youngest is in school full time and my wife decides to go back to work that should double our income.  Might as well take advantage of the no taxes while we can.   DW  is concerned we will end up owing taxes if we don't put it all in traditional for the tax break.

Being as this is the first time we have achieved this saving point, we really don't know what we are doing and just want to plot the most optimal course.

Thanks for all the help.

MDM

  • Senior Mustachian
  • ********
  • Posts: 11477
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #1 on: October 05, 2017, 03:34:13 AM »
Making the traditional vs. Roth choice is all about the marginal tax rates - what you would save this year, vs. what you would pay when withdrawing.

See Traditional versus Roth - Bogleheads for more, but ignore the "General guidelines" because those rules of thumb will likely not apply to you.  E.g., you may be in the "0% bracket" but due to various credits your marginal saving rate may be much higher.

Are you sure about the 457 plan costs?  IIRC 3% is the worst best rate I've ever seen.  The way the EIC works, 457 savings (ignoring fees) are much more valuable to you than IRA.  See the case study spreadsheet if you want to run some "what if...?" scenarios.

TomTX

  • Walrus Stache
  • *******
  • Posts: 5345
  • Location: Texas
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #2 on: October 05, 2017, 05:11:40 AM »
Rule of thumb is that the 15% marginal tax bracket is the "tossup" for Traditional vs Roth. Lower brackets, do the Roth. Higher, do the Traditional*

You are definitely in Roth territory. When you are paying 0 tax either way and have a choice between "pay income tax later on this IRA money" and "never pay income tax later on this IRA money" - I would go with "no tax later" instead of "yes tax later"

If you already contributed to a Traditional this year, it's not too late to change your mind!

Your 457 sounds like total crap. You could try to get providers changed. This has been discussed in other threads - I've done it successfully at my work.

*When you get to MUCH higher income, it can flip back to Roth, but that's outside the scope of the current discussion.

MDM

  • Senior Mustachian
  • ********
  • Posts: 11477
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #3 on: October 05, 2017, 05:51:00 AM »
Rule of thumb is that the 15% marginal tax bracket is the "tossup" for Traditional vs Roth. Lower brackets, do the Roth. Higher, do the Traditional*

You are definitely in Roth territory. When you are paying 0 tax either way and have a choice between "pay income tax later on this IRA money" and "never pay income tax later on this IRA money" - I would go with "no tax later" instead of "yes tax later"
Careful to distinguish between "bracket" vs. "marginal rate".  These may be equal, but in many cases (in particular, OP's) they are not. 

The credits OP can get make the "rule of thumb" not appropriate here - in particular if there would be reasonable 457 options.  The 457 is more valuable than a tIRA due to EIC calculation, leading to marginal saving rates ~40% in the OP's situation.

sokoloff

  • Handlebar Stache
  • *****
  • Posts: 1191
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #4 on: October 05, 2017, 06:12:40 AM »
Currently making $49,000 gross, but with the kids and allowed deductions we pay zero taxes.  Only deductions are SS, Medicare and CA SDI.
Roth.

Why? Your current tax burden is extremely low and unlikely to be lower in retirement. (If you don't want to do a lot of math, you can think of "If my tax rate is higher now than in retirement, choose Traditional; if it's lower now than in retirement, choose Roth; if it's likely to be about the same, choose some of each.")

I don't see overall tax rates being lower 30 years from now than today. You also seem to imply that your career has an upward trajectory on income, meaning you're more likely to be choosing traditional later in your career.

Don't get tricked/enticed by the prospect of current year tax deductions (or worse, a refund check). Optimize over your lifetime of savings after taxes (more precisely, the net present value of same), not over this year's 1040.

MDM

  • Senior Mustachian
  • ********
  • Posts: 11477
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #5 on: October 05, 2017, 06:24:13 AM »
With a marginal tax saving rate ~40%, why would one use Roth instead of traditional?

Federal only:


Federal plus California state (to the extent the state tax calculation is correct):

Heroes821

  • Pencil Stache
  • ****
  • Posts: 604
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #6 on: October 05, 2017, 07:07:35 AM »
I don't know anything about 457 plans, but I think that what MDM is getting at is that if your taxes are already down to 0 that is great, but now it's time to maximum those refundable tax credits. With three kids and your gross income it could result in a significant increase in tax refunds every year.


TomTX

  • Walrus Stache
  • *******
  • Posts: 5345
  • Location: Texas
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #7 on: October 05, 2017, 04:21:48 PM »
I don't know anything about 457 plans, but I think that what MDM is getting at is that if your taxes are already down to 0 that is great, but now it's time to maximum those refundable tax credits. With three kids and your gross income it could result in a significant increase in tax refunds every year.

MDM has a good point about using the 457 to maximize the EIC, especially with 3 kids.

I had not addressed the 457, only what the OP was doing (Trad IRA) versus Roth IRA.

Traditional 457 contribution reduces income for the EIC calculation. Roth 457, Trad or Roth IRA do not.

It looks like OP would get a nice EIC boost from all income reductions down to $23,750 (2016 numbers. 2017 should be slightly higher)

https://apps.irs.gov/app/vita/content/globalmedia/earned_income_credit_table_1040i.pdf

jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #8 on: October 05, 2017, 06:35:33 PM »
Thanks everyone for the information, it appears that a ROTH IRA is the way to go for the remainder of this year. 

Just got news today at work, that starting in January we have a new 457 provider, Nationwide who has a collection of Vanguard index funds that are estimated to have much lower expense ratios.  Details come out in two weeks, so that is exciting news, guess I wasn't the only one to notice the high expenses.




jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #9 on: October 05, 2017, 06:48:47 PM »
I don't know anything about 457 plans, but I think that what MDM is getting at is that if your taxes are already down to 0 that is great, but now it's time to maximum those refundable tax credits. With three kids and your gross income it could result in a significant increase in tax refunds every year.

MDM has a good point about using the 457 to maximize the EIC, especially with 3 kids.

I had not addressed the 457, only what the OP was doing (Trad IRA) versus Roth IRA.

Traditional 457 contribution reduces income for the EIC calculation. Roth 457, Trad or Roth IRA do not.

It looks like OP would get a nice EIC boost from all income reductions down to $23,750 (2016 numbers. 2017 should be slightly higher)

https://apps.irs.gov/app/vita/content/globalmedia/earned_income_credit_table_1040i.pdf


I think I follow what you and MDM are saying on the 457 route and maximizing the EIC, which sounds fantastic. 

It appears with a new 457 provider coming on line, this may be the route to take with next years savings.

Edit:  Deleted section on how to calculate AGI, because I realized there was more on the second page of the form and was able to duplicate TomTX's numbers.
« Last Edit: October 05, 2017, 07:18:02 PM by jdhansen »

MDM

  • Senior Mustachian
  • ********
  • Posts: 11477
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #10 on: October 05, 2017, 07:42:24 PM »
I think I follow what you and MDM are saying on the 457 route and maximizing the EIC, which sounds fantastic. 

It appears with a new 457 provider coming on line, this may be the route to take with next years savings.
Why wait?

At this point you're looking at only a few months of the high fees, which the EIC will more than cover.

See To 401k or not to 401k? That is the question. for more on how one should look at high fee tax-advantaged plans. 

TomTX

  • Walrus Stache
  • *******
  • Posts: 5345
  • Location: Texas
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #11 on: October 05, 2017, 08:30:08 PM »
I think I follow what you and MDM are saying on the 457 route and maximizing the EIC, which sounds fantastic. 

It appears with a new 457 provider coming on line, this may be the route to take with next years savings.
Why wait?

At this point you're looking at only a few months of the high fees, which the EIC will more than cover.

See To 401k or not to 401k? That is the question. for more on how one should look at high fee tax-advantaged plans. 

Yep, I would investigate how much I can dump into the 457 this year and reverse the IRA contributions to fund it.

Just pick the fund with no load, and after that lowest fees. Money should only be in there for a few months (ie, minimal cost compared to EIC benefit) then transfer to a Vanguard fund with the new provider.

DavidAnnArbor

  • Handlebar Stache
  • *****
  • Posts: 2266
  • Age: 58
  • Location: Ann Arbor, Michigan
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #12 on: October 05, 2017, 09:57:44 PM »
Yes I would definitely pick up a copy of a 2016 tax return or software and try to figure out what it would take for you to get the Earned Income Tax Credit.
You should also get Child Tax Credit and Additional Child Tax Credit.

TomTX

  • Walrus Stache
  • *******
  • Posts: 5345
  • Location: Texas
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #13 on: October 06, 2017, 05:33:49 AM »
Yes I would definitely pick up a copy of a 2016 tax return or software and try to figure out what it would take for you to get the Earned Income Tax Credit.
You should also get Child Tax Credit and Additional Child Tax Credit.

All you have to do is look at that table I linked. MFJ, 3 kids, $49,000.

Yep, he's getting at least a small EIC.

The way I read the chart, every $50 he shifts to 457 means the Feds will pay him $10. Easy 20% return.

Not sure where the breakpoint will get him to a 40% return that MDM refers to.

teen persuasion

  • Handlebar Stache
  • *****
  • Posts: 1226
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #14 on: October 06, 2017, 06:26:11 AM »
I've mentioned a >40% rate in the past.  The phaseout rate on EITC is 21% (for multiple children).  My state matches EITC at 30%, which is equivalent to 6.3%.  Add on 4% state tax avoided and 10% fed tax avoided, and our contributions net us a 41.3% increase in tax refunds.

OP, we put as much as possible into DH's traditional 401k, to drive down AGI to max our eligible EITC.  Our state matches CTC at 33% as well, so our refundable credits are sizeable.  We use that additional income to fund our Roth IRAs - there's no additional advantage to using traditional IRAs for us, since there's no tax to avoid and traditional IRA contributions won't increase EITC.  So best of both worlds.

hoping2retire35

  • Handlebar Stache
  • *****
  • Posts: 1398
  • Location: UPCOUNTRY CAROLINA
  • just want to see where this appears
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #15 on: October 06, 2017, 07:07:13 AM »
Dude, I have three kids, and you make barely more than us. You should have been getting a check for $5-6k last year, who does your taxes?

I used turbo tax, and always get a credit refundable check. I would look at filing an amendment and trying to get a refund from previous years, if that is possible.

I am guessing you are just doing something wrong on your tax returns as opposed to your retirement account choice.

teen persuasion

  • Handlebar Stache
  • *****
  • Posts: 1226
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #16 on: October 06, 2017, 07:34:31 AM »
OP, also look at the effect of the Retirement Saver's credit.  You are in the income range to be eligible.  If only one of you has retirement contributions, your credit will be less.  The first $2k retirement contributions for each of you are entered in the calculation.  At your current AGI, you seem eligible for 10% of the first $2k, so up to $200 credit for one of you, or $400 if both have retirement contributions of at least $2k.  If you can get your AGI below the next threshold (IIRC, $40k for 2016, may be different for 2017), the rate increases to 20%, so doubles your credit.  If you can reach the lowest threshold ($37k for 2016?), it increases to 50%.

The Retirement Saver's credit is nonrefundable, so you can't get back anything over your tax liability, but it can free up the other refundable credits like EITC and CTC.

I look at this process as iterative - how much can I afford to defer to traditional retirement accounts?  How much in refunds does that net me?  Can I put that additional $ to retirement accounts too?  How much larger is my refund now?  Rinse and repeat until you run out of retirement account space, or zero actual tax, or chart limitations, or ??

Make sure to put some $ in retirement accounts in your spouse's name.  Partially to make best use of the Retirement Saver's credit, partially to spread the balances between you.  As a longtime SAHM (now working part-time, still no 401k) I now regret not funding IRAs for me earlier.  We view DH's 401k balance as "ours", but I recently learned of a state tax rule that will affect us in retirement: the first $20k of income from retirement accounts PER PERSON is tax free annually.  However, it cannot be lumped together in a couple - if I have no taxable retirement income, we only have $20k tax free space for DH's retirement income, instead of the possible $40k.  The more you know, the better you can plan.

sokoloff

  • Handlebar Stache
  • *****
  • Posts: 1191
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #17 on: October 06, 2017, 08:59:19 AM »
Dude, I have three kids, and you make barely more than us. You should have been getting a check for $5-6k last year, who does your taxes?
If you're getting a check for $5-6K/yr, who fills out your W-4?

Heroes821

  • Pencil Stache
  • ****
  • Posts: 604
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #18 on: October 06, 2017, 09:13:28 AM »
Dude, I have three kids, and you make barely more than us. You should have been getting a check for $5-6k last year, who does your taxes?
If you're getting a check for $5-6K/yr, who fills out your W-4?

Lower income, lots of kids and refundable tax credits. Their withholding could be perfectly calculated but if they qualify for refundable credits...BOOM! Big check every year.

teen persuasion

  • Handlebar Stache
  • *****
  • Posts: 1226
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #19 on: October 06, 2017, 09:19:41 AM »
Dude, I have three kids, and you make barely more than us. You should have been getting a check for $5-6k last year, who does your taxes?
If you're getting a check for $5-6K/yr, who fills out your W-4?

Good point - once you get yourself into the range of refundable credits > tax owed, it's time to turn off tax withholdings.  Even with zero tax withholdings, we had $11k refunds some years.  Not so large now that most kids are > 17.

hoping2retire35

  • Handlebar Stache
  • *****
  • Posts: 1398
  • Location: UPCOUNTRY CAROLINA
  • just want to see where this appears
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #20 on: October 06, 2017, 10:33:10 AM »
Dude, I have three kids, and you make barely more than us. You should have been getting a check for $5-6k last year, who does your taxes?
If you're getting a check for $5-6K/yr, who fills out your W-4?

Lower income, lots of kids and refundable tax credits. Their withholding could be perfectly calculated but if they qualify for refundable credits...BOOM! Big check every year.

yep. I put 'Exempt' on my employer form. and yes, BOOM! refundable tax credits. OP is in a very similar situation he should be getting bank.

MDM

  • Senior Mustachian
  • ********
  • Posts: 11477
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #21 on: October 06, 2017, 11:06:37 AM »
Not sure where the breakpoint will get him to a 40% return that MDM refers to.
As others have mentioned, the 40% comes from a combination of several things.  See the case study spreadsheet for how those graphs were developed.

jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #22 on: October 06, 2017, 02:05:46 PM »
Dude, I have three kids, and you make barely more than us. You should have been getting a check for $5-6k last year, who does your taxes?

I used turbo tax, and always get a credit refundable check. I would look at filing an amendment and trying to get a refund from previous years, if that is possible.

I am guessing you are just doing something wrong on your tax returns as opposed to your retirement account choice.

Our average refund has been right around $5K since the youngest was born.  I wasn't considering the EIC portion of that return when trying to figure out where to stick extra money.  Having this additional money to invest  is a new thing for us as we finally eliminated all our debts.

Also Tax refunds have always been DW to use as she see fits, so I never considered it as money to be invested.  Usually she uses it for birthday parties, clothes, sports, Christmas presents, extra expenses through out the year.  The fact that she has been able to stretch it out as far as she can while paying down our debts has been truly amazing to me.  If there is a way to increase its size based on where we put extra money that seems valuable to me.
« Last Edit: October 06, 2017, 02:24:38 PM by jdhansen »

jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #23 on: October 06, 2017, 02:11:46 PM »
I think I follow what you and MDM are saying on the 457 route and maximizing the EIC, which sounds fantastic. 

It appears with a new 457 provider coming on line, this may be the route to take with next years savings.
Why wait?

At this point you're looking at only a few months of the high fees, which the EIC will more than cover.

See To 401k or not to 401k? That is the question. for more on how one should look at high fee tax-advantaged plans. 

To be honest, it is more for the DW comfort about this whole process and idea. 

Her fear of the 457 is that it will mess up our cash flow and really screw us if something terrible happens.  Convincing her that we have a solid 6 month emergency fund in the bank and the IRA is easy to get to if necessary was this years struggle. 

Now I can start working on convincing her of the benefits of the 457 plan and letting her take a few months to think while creating the budget for the next year is the easiest way to do that.

It has been quite a time changing the mind set from how to survive pay check to pay check to what do we do with these extra funds we don't have to spend.

jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #24 on: October 06, 2017, 02:18:19 PM »
OP, also look at the effect of the Retirement Saver's credit.  You are in the income range to be eligible.  If only one of you has retirement contributions, your credit will be less.  The first $2k retirement contributions for each of you are entered in the calculation.  At your current AGI, you seem eligible for 10% of the first $2k, so up to $200 credit for one of you, or $400 if both have retirement contributions of at least $2k.  If you can get your AGI below the next threshold (IIRC, $40k for 2016, may be different for 2017), the rate increases to 20%, so doubles your credit.  If you can reach the lowest threshold ($37k for 2016?), it increases to 50%.

The Retirement Saver's credit is nonrefundable, so you can't get back anything over your tax liability, but it can free up the other refundable credits like EITC and CTC.

I look at this process as iterative - how much can I afford to defer to traditional retirement accounts?  How much in refunds does that net me?  Can I put that additional $ to retirement accounts too?  How much larger is my refund now?  Rinse and repeat until you run out of retirement account space, or zero actual tax, or chart limitations, or ??

Make sure to put some $ in retirement accounts in your spouse's name.  Partially to make best use of the Retirement Saver's credit, partially to spread the balances between you.  As a longtime SAHM (now working part-time, still no 401k) I now regret not funding IRAs for me earlier.  We view DH's 401k balance as "ours", but I recently learned of a state tax rule that will affect us in retirement: the first $20k of income from retirement accounts PER PERSON is tax free annually.  However, it cannot be lumped together in a couple - if I have no taxable retirement income, we only have $20k tax free space for DH's retirement income, instead of the possible $40k.  The more you know, the better you can plan.

Excellent advice,  and something definitely something to consider for DW to have her own account as she has been a SAHM as well.  At this point we have maxed my IRA space, and were trying to figure out the best type of IRA to open for her with the remainder. 

As I have learned from this forum while lurking, everyone is awesome and we have gotten a ton of quality information we are going to have to digest and discuss.   

Thanks again to everyone for the information and discussions, it has been eye opening and reassuring at the same time.

WhiteTrashCash

  • Handlebar Stache
  • *****
  • Posts: 1983
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #25 on: October 06, 2017, 02:25:50 PM »
One nice feature of the Roth IRA that hasn't been mentioned yet but can be quite helpful for lower income folks is that you can withdraw your contributions without penalty in an emergency. That was the initial reason I chose to start a Roth IRA instead of a traditional IRA. Just remember that you can only withdraw your contributions, not the capital gains or dividends.

TomTX

  • Walrus Stache
  • *******
  • Posts: 5345
  • Location: Texas
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #26 on: October 06, 2017, 08:24:08 PM »
I think I follow what you and MDM are saying on the 457 route and maximizing the EIC, which sounds fantastic. 

It appears with a new 457 provider coming on line, this may be the route to take with next years savings.
Why wait?

At this point you're looking at only a few months of the high fees, which the EIC will more than cover.

See To 401k or not to 401k? That is the question. for more on how one should look at high fee tax-advantaged plans. 

To be honest, it is more for the DW comfort about this whole process and idea. 

Her fear of the 457 is that it will mess up our cash flow and really screw us if something terrible happens.  Convincing her that we have a solid 6 month emergency fund in the bank and the IRA is easy to get to if necessary was this years struggle. 

Now I can start working on convincing her of the benefits of the 457 plan and letting her take a few months to think while creating the budget for the next year is the easiest way to do that.

It has been quite a time changing the mind set from how to survive pay check to pay check to what do we do with these extra funds we don't have to spend.


Keep in mind that the 457 is unique in that you can withdraw money without penalty (you do have to pay tax) anytime after you leave that employer. No age requirement. So, lets say the big fear is that you lose your job and need to draw something from retirement to get by til your next job.

457 has you covered. No penalty. Contributions AND gains. The closest other account type to that feature is a Roth, where you can withdraw the contributions (but NOT gains) anytime without penalty.

jdhansen

  • 5 O'Clock Shadow
  • *
  • Posts: 78
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #27 on: October 07, 2017, 05:35:24 PM »
[quote author=TomTX link=topic=79867.msg1723522#msg1723522 date=1507343048


Keep in mind that the 457 is unique in that you can withdraw money without penalty (you do have to pay tax) anytime after you leave that employer. No age requirement. So, lets say the big fear is that you lose your job and need to draw something from retirement to get by til your next job.

457 has you covered. No penalty. Contributions AND gains. The closest other account type to that feature is a Roth, where you can withdraw the contributions (but NOT gains) anytime without penalty.
[/quote]

That is excellent news.  I will bring this up in our conversation tonight, as we have to talk budget as we just got the news that DW car possible have a cracked head gasket or warped cylinder.  But won't know for sure until Monday.  Extra funds may be going that way instead :)

TomTX

  • Walrus Stache
  • *******
  • Posts: 5345
  • Location: Texas
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #28 on: October 07, 2017, 07:07:10 PM »
Not sure where the breakpoint will get him to a 40% return that MDM refers to.
As others have mentioned, the 40% comes from a combination of several things.  See the case study spreadsheet for how those graphs were developed.

That's a pretty amazing spreadsheet. I have started poking around at the current version...

MDM

  • Senior Mustachian
  • ********
  • Posts: 11477
Re: Is a Roth IRA the right choice at this time for my Family?
« Reply #29 on: October 07, 2017, 07:37:12 PM »
That's a pretty amazing spreadsheet. I have started poking around at the current version...
Any questions, just ask.

 

Wow, a phone plan for fifteen bucks!