IRA vs other accounts

[Sam E]

I'm going to be free of my debt before long (like a year, but hey) and I'm trying to learn about investing, a topic which I'm quite ignorant on, before I get to that point. Recently I've been wondering whether an IRA is a good idea for someone in my position and with my goals (mainly achieving FIRE as soon as I can). My yearly income is about $22k and my expenses work out to about $10.5k.

I'll have about $11,500 to save each year, which could mean $5.5k in IRA and $6k in other accounts each year, not including any gains and assuming I make the same amount of money for the foreseeable future. But what gives me pause about this is the fact that my goal is early retirement, but an IRA can't be withdrawn from until age 59.5 without incurring heavy penalties. Given that my investment money isn't huge, it makes me want to put it all somewhere I could access it when needed without penalty. I know IRAs aren't taxable, but is that worth the constraints?

My question is, am I thinking correctly? Am I totally off-base? Please help enlighten me so I can make a more educated decision. I know I have a lot to learn, and plenty of time to learn it, but this particular problem has bugged me and I figure it's a good place to start.

[skyrefuge]

Yes, given your income level, contributing to a Roth IRA now would have a huge upside, with essentially no downside. Read the following to learn why IRA money is not actually inaccessible:

https://seattlecyclone.com/accessing-your-retirement-accounts-early-yes-you-can/

[Sam E]

Yes, given your income level, contributing to a Roth IRA now would have a huge upside, with essentially no downside. Read the following to learn why IRA money is not actually inaccessible:

https://seattlecyclone.com/accessing-your-retirement-accounts-early-yes-you-can/

Thank you for the link. It was a good read and I'm bookmarking it for future reference as well. It helped some of my confusion/apprehension and shows I certainly have my work cut out for me as far as learning how all these things work.

[MDM]

Based on a quick look at your numbers, if you contribute ~$4,000 to a traditional IRA you will qualify for the maximum saver's credit and drop your federal tax from ~$1,300 to $0.00 for the year. 

Does that seem correct to you?

[skyrefuge]

Based on a quick look at your numbers, if you contribute ~$4,000 to a traditional IRA you will qualify for the maximum saver's credit and drop your federal tax from ~$1,300 to $0.00 for the year. 

Oh, yeah, I was assuming a Roth IRA contribution would also allow the Saver's Credit to be maxed out (at $1000), but I didn't realize the AGI phase-out was that low for single filers; a maxed-out Roth contribution would only result in a $550 credit. So a Traditional contribution (or partial Traditional, partial Roth) might be a better choice in this case.

[MDM]

a maxed-out Roth contribution would only result in a $550 credit.

Maybe as little as a $200 credit?  From the case study sticky spreadsheet with $5500 going to Roth:

Filing Status	1	1=S, 2=MFJ
# of earners	1
Total Income	$22,000
Std. Deduct.	$6,300
Act. Deduct.	$6,300
# Exempt.	1
Exemption	$4,000
Taxable	$11,700
Tax	$1,294
Savers' credit	$200
Tax after n-r credit	$1,094
# Children <17	0
Child Tax Cred.	$0
EIC	$0
Net Tax	$1,094

If it should be $550, let me know and I'll revise the spreadsheet.

[skyrefuge]

Maybe as little as a $200 credit? .

Ugh, yeah. I just thought "10% of $5500", but of course the 10% only applies to the first $2000. I should have just posted the link and kept my damn mouth shut on the rest. Though I'll choose to say my wrong advice was just a nice way to illustrate how stupidly and unnecessarily complex the Saver's Credit is. The Venn diagram between "people with income low enough for the Saver's Credit", "people with savings high enough to take advantage of it", and "people who understand it well enough to optimally exploit it" has to encompass about 6 people.

[MDM]

The Venn diagram between "people with income low enough for the Saver's Credit", "people with savings high enough to take advantage of it", and "people who understand it well enough to optimally exploit it" has to encompass about 6 people.

LOL

Well said.

[Sam E]

So, given the information about the Saver's Credit and how much I'd be contributing, would that mean I might actually benefit from putting my money into a traditional IRA rather than a Roth IRA, or am I interpreting this incorrectly?

[Emilyngh]

 The Venn diagram between "people with income low enough for the Saver's Credit", "people with savings high enough to take advantage of it", and "people who understand it well enough to optimally exploit it" has to encompass about 6 people.

Wellll, count me as one of the 6.   And I've probably read of more than 6 right here on this board who use it.   One's income doesn't really have to be so low if they well utilize 401ks and IRAs.   IIRC, the AGI cap out for the saver's credit for 2015 for a married couple is over $60k.   So, if they both are fully contributing to IRAs and 401ks, their joint income can be over $100k.   One could imagine that considering pretax income deductions for employer sponsored health insurance/FSA/HSA, a couple might even qualify with a net income of over $120k.

I agree that the average American certainly doesn't save this much, but it's something that people (esp Mustachians) should consider as another potential benefit to staching.

[brooklynguy]

Though I'll choose to say my wrong advice was just a nice way to illustrate how stupidly and unnecessarily complex the Saver's Credit is. The Venn diagram between "people with income low enough for the Saver's Credit", "people with savings high enough to take advantage of it", and "people who understand it well enough to optimally exploit it" has to encompass about 6 people.

And each of those six people is surely either an early retiree or someone actively trying to become one.

Your apt description is a microcosm of the entire federal tax regime, where the intersection between rules that favor (and, I'd go as far as to say, were designed to favor) the rich and rules designed to give a break to the poor is exploitable by (and in fact optimally exploited probably almost only by) early retirees and aspiring early retirees.  The tax sector, like nature, abhors a vacuum, so we FIRE-seekers have collectively found the space between the progressive and regressive aspects of our tax system, and filled it.

[teen persuasion]

The Venn diagram between "people with income low enough for the Saver's Credit", "people with savings high enough to take advantage of it", and "people who understand it well enough to optimally exploit it" has to encompass about 6 people.

Don't forget the subset of "taxes > $0".

We are eligible by income (after 401k and HSA contributions), but with the kids' exemptions we generally owe no tax, and the credit is nonrefundable.  This year I thought we might get to make use of the credit, but, nope.  Our small amount of tax was wiped out by the nonrefundable portion of the college credit first.

[seattlecyclone]

So, given the information about the Saver's Credit and how much I'd be contributing, would that mean I might actually benefit from putting my money into a traditional IRA rather than a Roth IRA, or am I interpreting this incorrectly?

You're interpreting it correctly. The saver's credit has a few different income "brackets" of its own to qualify for a better credit. By making pre-tax contributions until you're in the next level down and then making Roth contributions, you increase your saver's credit.

[MDM]

Yes, despite being in a low marginal bracket now putting some money into a traditional IRA to ensure your AGI is <$18K would make a large difference in the Saver's Credit.

E.g., see these web pages that will help evaluate some "what if?" options:
http://www.paycheckcity.com/calculator/salary/ or
http://www.bankrate.com/calculators/tax-planning/1040-form-tax-calculator.aspx or
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/,
or you could also use the spreadsheet linked in the case study sticky to evaluate your options.

It would be a shame to miss the saver's credit cutoff by a few $.  If you are trying to cut it close, do ensure that you are using 2015 tables with whatever tool(s) you choose.

[Sam E]

After reviewing one of those calculators, I think I was presenting the wrong information. I was thinking only about my take-home pay rather than the bigger picture of gross income. According to the calculator my AGI is actually right about $30k, so simply contributing $5.5k to a traditional IRA wouldn't drop me into the <$18k range for the maximum Saver's Credit.

So, sorry about that slip on my part, again I'm VERY new to actually thinking and talking about financial and tax matters in any meaningful sense. But thanks again for all the information, it's still very applicable. I feel like my understanding has grown a lot just from this, so I've got a nice jumping off point into what to start researching next.

[MDM]

my AGI is actually right about $30k

my expenses work out to about $10.5k.

I'll have about $11,500 to save each year

There is still a bunch of unaccounted money - taxes won't be $8K - but up to you how to pursue.  Good luck!

[Sam E]

There is still a bunch of unaccounted money - taxes won't be $8K - but up to you how to pursue.  Good luck!

The estimates are admittedly very rough for various reasons. I'm hourly and get a couple hours of overtime each week, so I've been going on minimums and averages just to get some rough ideas. My initial numbers were just based on my average paycheck times 24. Like I said earlier, I'm just starting to take real notice and control of my finances, so once I start really getting down to it and tracking everything and learning more it should be WAY more solid.