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Learning, Sharing, and Teaching => Investor Alley => Topic started by: DoubleDown on March 28, 2013, 09:55:42 AM

Title: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: DoubleDown on March 28, 2013, 09:55:42 AM
I posted this question earlier but it seemed to get wiped out in the website move. Sorry if you already responded and I missed it:

Anyone considering contributing to an IRA after reaching FI/RE? This scenario seems like it would make sense mathematically, you'd just give up some possible flexibility in return:

Assume you are FI/RE, married, living on a $40,000 annual budget. You (or your spouse) earn earn at least $10,000/year in side income, so you meet the criteria for both being able to contribute to an IRA. Without the side income, you would withdraw $40,000 from your stash to meet expenses. With side income, you only need to withdraw $30,000. Rough estimate is that you'd pay approximately $1000-2000 in income taxes on your stash withdrawals and side income.

But instead of withdrawing only $30,000 from your stash, you could still withdraw $40,000 to meet expenses, and put all the side earnings ($10,000) into IRA's. You would then get the tax break from the IRA contributions -- probably worth about $1000 - $2000 annually -- effectively wiping out your income tax. The downside of course is that the money you contributed would be tied up in the usual ways for tax advantaged accounts. You'd have to go through the various loopholes to pull it out early, or plan accordingly to have enough in non-tax advantaged accounts before age 59.5. Does this make sense to do? Am I missing any other obvious drawbacks?
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: unitsinc on March 28, 2013, 10:07:08 AM
I guess my biggest question is why not do both?

Contribute before and after FI?
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: DoubleDown on March 29, 2013, 08:33:21 AM
I guess my biggest question is why not do both?

Contribute before and after FI?

My wife's and my combined incomes are too high to qualify for IRA contributions right now (a great "problem" to have). But when I retire this year or next, we will have very little earned income, so we would be eligible to start contributing. So my question is, does it make sense when I retire (age 46) to start withdrawing from the non-IRA accounts and rolling that money over into IRA's, knowing that we'll be tying that money up for a little while? We already have more than enough in 401k's/IRA's for our later years, but I wonder if it's worth it for the tax advantages.
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: GreenGuava on March 29, 2013, 08:53:55 AM
But when I retire this year or next, we will have very little earned income, so we would be eligible to start contributing.

How little earned income?  Recall that IRA contributions are capped at that year's earned income (or the IRS maximum, whichever is smaller).  So, for example, if someone in your position, but further down the road, earned $2000 in 2013, he or she would only be able to contribute $2000 to an IRA.
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: JohnGalt on March 29, 2013, 09:00:46 AM
I guess my biggest question is why not do both?

Contribute before and after FI?

My wife's and my combined incomes are too high to qualify for IRA contributions right now (a great "problem" to have). But when I retire this year or next, we will have very little earned income, so we would be eligible to start contributing. So my question is, does it make sense when I retire (age 46) to start withdrawing from the non-IRA accounts and rolling that money over into IRA's, knowing that we'll be tying that money up for a little while? We already have more than enough in 401k's/IRA's for our later years, but I wonder if it's worth it for the tax advantages.

You should be able to run some numbers to figure this out.  I'd think it would depend on how much earned income you actually have and when you'll need the money.

If it was me and your marginal tax rate is as low as it seems like it would be on that earned income, I would think roth IRA contributions would make more sense.  You should be in a very low tax bracket at that point and, I'd imagine, not need the money for a long time.  Why not lock in the low taxes now and then not have to pay any taxes on the contributions/earnings in the future?  Plus, the roth contributions can be withdrawn tax/penalty free at any time should something come up where you need access to it.

Also - I believe there is still no income limit on backdoor roth contributions, should you want to start contributing now. 
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: Chris on March 29, 2013, 11:16:42 AM
In the scenario you describe, married with annual income of $40k, you'd be eligible for the Saver's Credit (http://"http://www.irs.gov/uac/Get-Credit-for-Your-Retirement-Savings-Contributions"). So while you would be locking up some of the income in the IRA, you'd also get an "instant rebate" on the contribution.
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: DoubleDown on March 29, 2013, 02:16:35 PM
All great suggestions, thanks!
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: grantmeaname on March 31, 2013, 08:03:22 AM
I posted this question earlier but it seemed to get wiped out in the website move.
I was wondering where this thread went!

Quote
Am I missing any other obvious drawbacks?
You're basically proposing the opposite of the Roth conversion pipeline, wherein you convert a year's worth of expenses from traditional to Roth accounts each year and pay a little bit of tax on it. Here, you're talking about converting $10,000 of taxable accounts to traditional IRA accounts each year, and getting paid a little bit of negative taxes on it. You're guaranteed to be losing flexibility on doing so, though -- will you have enough in your taxable accounts to pay you and your IRAs $40,000 a year until you're 59.5?
Title: Re: Not Investing in IRA Until FI'ed Part II: The Revenge
Post by: DoubleDown on April 01, 2013, 01:07:03 PM
Here, you're talking about converting $10,000 of taxable accounts to traditional IRA accounts each year, and getting paid a little bit of negative taxes on it. You're guaranteed to be losing flexibility on doing so, though -- will you have enough in your taxable accounts to pay you and your IRAs $40,000 a year until you're 59.5?

Yeah, that's the gist of it, we would definitely be giving up some flexibility in the process as I see it, at least for a short time. My example was actually hypothetical, attempting to simplify to get to the basic question. In reality, my (slightly younger) wife wants to continue working full time even after I retire, at least for a couple of years, so there will be at least enough earned income where taxes will be a consideration for us. Also we have young kids, and we'd like to keep them in school where we live. The tradeoff is it will keep us in a higher cost of living area, with equity tied up in our home, where I'll have to withdraw from the taxable accounts too in order to meet our expenses, until I'm 59.5 and start 401k/IRA/pension withdrawals.

When I've run the tax simulations with her income and our usual deductions, we'll end up paying about $2,000 in income taxes. That's where I was thinking making IRA contributions for both of us might make sense, even if it means having to withdraw some additional funds from the taxable accounts to do so. We could do this for several years, then switch over to the Roth pipeline method.

At least we can take advantage of one of the great things about IRA's, contributing to them up until April of the following tax year. So, we can do our taxes first, see if we're going to have any net income tax and, if so, make a contribution to offset the tax as desired.

Thanks again for everyone's suggestions, I'm going to be following up on them -- such as "back door Roth contributions" now, etc. And I had never even heard of a Roth pipeline until coming to this forum last year.