Author Topic: Roth IRA or Traditional Based On My Salary  (Read 4539 times)

beeps_mustache

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Roth IRA or Traditional Based On My Salary
« on: June 29, 2015, 09:40:44 PM »
Hey all,

Hoping to get some help from the mighty might Mustachians on something I'm kinda confused on. The MAGI on an IRA this year is $61k. My salary was bumped up to $88k in March and I also received a $10k bonus from my employer at the same time. I was stoked! However, now I'm wondering if I can file for an IRA or if I need to plop that money instead into a Roth? After maxing out the 401k, I'd be at $70k but are there any other tricks to lower my MAGI? Also, wouldn't the bonus work against me in this case as well? Lastly, even if I can open an IRA, I feel like I'd just be on the threshold of the $61k (and I could be very ignorantly incorrect about this). Assuming a raise next year, would it be worth opening an IRA for just one year?

Any help would be greatly appreciated. 'Stash on!

seattlecyclone

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Re: Roth IRA or Traditional Based On My Salary
« Reply #1 on: June 29, 2015, 10:07:03 PM »
Sounds like you've probably earned yourself out of the ability to make deductible traditional IRA contributions. Even if your max out your HSA and 401(k) you'll probably still be too high to make a full deductible contribution. Well done! Go ahead and make Roth contributions and celebrate your high earning power.

beeps_mustache

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Re: Roth IRA or Traditional Based On My Salary
« Reply #2 on: June 29, 2015, 10:23:55 PM »
Awesome. Just wanted to get confirmation that I wasn't missing anything! Thanks!!!

dandarc

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Re: Roth IRA or Traditional Based On My Salary
« Reply #3 on: June 30, 2015, 07:55:38 AM »
Also remember that you don't have to guess right on the tIRA vs Roth.  You can re-characterize all or part of your contribution by your tax filing deadline.  If you file your taxes on time, they even give you an automatic extension for this, so you've got until October 15, 2016 to do the recharacterization, although I'd want to have it done by April 15 so I didn't have to also file an amended return.

Mr. McGibblets

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Re: Roth IRA or Traditional Based On My Salary
« Reply #4 on: June 30, 2015, 08:18:42 AM »
Nicely done!

laughing_paddler

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Re: Roth IRA or Traditional Based On My Salary
« Reply #5 on: June 30, 2015, 08:44:15 AM »
Also remember that you don't have to guess right on the tIRA vs Roth.  You can re-characterize all or part of your contribution by your tax filing deadline.  If you file your taxes on time, they even give you an automatic extension for this, so you've got until October 15, 2016 to do the recharacterization, although I'd want to have it done by April 15 so I didn't have to also file an amended return.

Wait, what?

I had no idea dandarc that I could do this. I've been grumbling lately that I suspect DW and I overpaid income taxes last year by contributing to roths on auto without thinking about our slightly higher income was maybe going to bump us up to 25% marginal tax rate, and could have saved by going traditional instead. And our tax preparers had nothing to say about this either... Looks like I'll be finally learning how to do our taxes myself.

glad I clicked on this thread

johnny847

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Re: Roth IRA or Traditional Based On My Salary
« Reply #6 on: June 30, 2015, 08:49:58 AM »
Also remember that you don't have to guess right on the tIRA vs Roth.  You can re-characterize all or part of your contribution by your tax filing deadline.  If you file your taxes on time, they even give you an automatic extension for this, so you've got until October 15, 2016 to do the recharacterization, although I'd want to have it done by April 15 so I didn't have to also file an amended return.

Wait, what?

I had no idea dandarc that I could do this. I've been grumbling lately that I suspect DW and I overpaid income taxes last year by contributing to roths on auto without thinking about our slightly higher income was maybe going to bump us up to 25% marginal tax rate, and could have saved by going traditional instead. And our tax preparers had nothing to say about this either... Looks like I'll be finally learning how to do our taxes myself.

glad I clicked on this thread

Just make sure as noted on this thread that there is an income limit (strictly speaking a MAGI limit) to be able to deduct contributions to a tIRA.

And yup, recharacterizing is a great trick. I'm borderline 25% bracket with no workplace retirement plan. I want to make tIRA contributions until I'm just inside the 15% bracket, so instead of waiting until March or something to make a contribution for the previous year, I just contribute to either of my IRAs without worrying about how I should split my contributions between them, if at all. Then come tax time, I figure out how much I want to recharacterize, if any, and then call up Vanguard to get that done.

laughing_paddler

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Re: Roth IRA or Traditional Based On My Salary
« Reply #7 on: June 30, 2015, 11:05:09 AM »
Also remember that you don't have to guess right on the tIRA vs Roth.  You can re-characterize all or part of your contribution by your tax filing deadline.  If you file your taxes on time, they even give you an automatic extension for this, so you've got until October 15, 2016 to do the recharacterization, although I'd want to have it done by April 15 so I didn't have to also file an amended return.

Wait, what?

I had no idea dandarc that I could do this. I've been grumbling lately that I suspect DW and I overpaid income taxes last year by contributing to roths on auto without thinking about our slightly higher income was maybe going to bump us up to 25% marginal tax rate, and could have saved by going traditional instead. And our tax preparers had nothing to say about this either... Looks like I'll be finally learning how to do our taxes myself.

glad I clicked on this thread

Just make sure as noted on this thread that there is an income limit (strictly speaking a MAGI limit) to be able to deduct contributions to a tIRA.

And yup, recharacterizing is a great trick. I'm borderline 25% bracket with no workplace retirement plan. I want to make tIRA contributions until I'm just inside the 15% bracket, so instead of waiting until March or something to make a contribution for the previous year, I just contribute to either of my IRAs without worrying about how I should split my contributions between them, if at all. Then come tax time, I figure out how much I want to recharacterize, if any, and then call up Vanguard to get that done.

Yes thanks, I have done some reading about income limits for contribution deductions, and up until last week, I knew the answer to our household was full deduction up to 183k (DW has 403b, I do not) so we WERE all set.

But- (and I'm sorry if I'm hijacking the thread here, but the question and answer may be of interest to people following) as of tomorrow, my status changes slightly- I will be newly a part of a large institution with a pension (I must wait 4.75 years to be fully vested, question on this later) and a 403b option (no employer match from what I can tell).

So a question- does the existence of a 403b OPTION (with no match and only expensive fund options from what I can tell right now) mean that DW and I are now subject to the much lower 98k income limits for tIRA deductions? Are the income limits contingent on the OPTION or my PARTICIPATION?

Also, does the existence of the pension matter at all to the above discussion? Especially if I have no benefit until 4.75 years?

Sorry for the wandering questions here- obviously there's a lot for me to learn...

dandarc

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Re: Roth IRA or Traditional Based On My Salary
« Reply #8 on: June 30, 2015, 11:34:58 AM »
If your employer has a plan that you could participate in, then you are "covered by a plan at work" and subject to the lower limit for IRA deductions.  Even if you choose not to participate.

Quote
I knew the answer to our household was full deduction up to 183k (DW has 403b, I do not) so we WERE all set.

This isn't quite right.  You had a 183K (2015) limit for a full deduction.  Your wife had a 98K (2015) limit.  The "I" in IRA is for "Individual" after all.

laughing_paddler

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Re: Roth IRA or Traditional Based On My Salary
« Reply #9 on: June 30, 2015, 02:35:55 PM »
thanks for the tips dandarc- still have a lot to learn in this dept. guess that new taxes thread is where I'm spending some time next...

laughing_paddler

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Re: Roth IRA or Traditional Based On My Salary
« Reply #10 on: June 30, 2015, 09:29:53 PM »
Okay, so it was bugging me all afternoon and I had to go back and look what the "preparers" did on our return last year.

Re: the IRA re-characterization... do I have a case here?

MFJ, 1 child, we both maxed out RothIRAs  @5500 each.
AGI = 108429
- 12400 std ded
- 11850 exemp
= 84179 taxable
Tax = 12756

Since we're in the range for reduced deductions, I calculate (MAGI is 109031):
re-characterize all of my Roth (I had no plan at work, and earned below 181k) = 5500
re-characterize 27.5% of DW's line 6a on the IRA deduction worksheet (she had a plan at work) = 1920
5500+1920 = 7420
NEW AGI = 101009
- 12400
- 11850
= 76759
Tax = 10906

for a difference of $1850...

For some reason, the tax preparer dropped off filling out my side of the IRA deduction worksheet and never suggested that we consider re-characterizing the Roth contributions, so I'm worried I'm missing something... AM I?

-thanks in advance for a tax noob.

MDM

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Re: Roth IRA or Traditional Based On My Salary
« Reply #11 on: June 30, 2015, 09:37:28 PM »
AGI = 108429

Since we're in the range for reduced deductions, I calculate (MAGI is 109031):
A few things:
 - how do you go from an AGI of 108429 to an MAGI of 109031?  Are they for the same year?
 - you don't get to deduct the tIRA contribution to decrease your MAGI.  In other words, if you deducted a tIRA contribution to get your AGI you have to add it back to get your MAGI.
 - I believe the calculations in the case study spreadsheet are correct.  You could enter your numbers there and see what you get.

laughing_paddler

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Re: Roth IRA or Traditional Based On My Salary
« Reply #12 on: June 30, 2015, 09:50:29 PM »
602 student loan interest. I'm just working off the tax preparer's doc (2014) here.

These weren't tIRA contributions so they aren't already deducted. That's the whole point of the re-characterization right?

MDM

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Re: Roth IRA or Traditional Based On My Salary
« Reply #13 on: June 30, 2015, 10:05:53 PM »
These weren't tIRA contributions so they aren't already deducted. That's the whole point of the re-characterization right?

The re-characterization won't change your MAGI, but it will decrease your AGI thus your taxable income thus your tax.  The amount you can re-characterize is set by your MAGI.

Does that make sense?

johnny847

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Re: Roth IRA or Traditional Based On My Salary
« Reply #14 on: June 30, 2015, 10:39:16 PM »
These weren't tIRA contributions so they aren't already deducted. That's the whole point of the re-characterization right?

The re-characterization won't change your MAGI, but it will decrease your AGI thus your taxable income thus your tax.  The amount you can re-characterize is set by your MAGI.

Does that make sense?

To expand on this point, the MAGi in this scenario is more or less your AGI before your tIRA deduction, while adding back a few things (such as the student loan interest deduction as you mentioned)

You are in the 25% bracket http://www.forbes.com/sites/kellyphillipserb/2015/05/14/2015-tax-rates-standard-deductions-personal-exemptions-credit-amounts-more/ before and after a rechar of your IRA contribution. To calculate the effect on the tax, you don't need to calculate the actual tax amount. Just use the marginal rate. You've reduced taxable income by $5500 in the marginal 25% bracket, so you've reduced your taxes by $5500 * 0.25 = $1375.

But, do you pay state income tax? If you do, you would then have to file an amended state return. Suppose your marginal state tax rate is 6%, that's another $330 you would get back.


Just keep in mind that what you're doing is deferring taxes. By recharing to a traditional, you're avoiding taxes now to pay them later. I still think this is a good idea, especially because if you FIRE you can use the Roth conversion pipeline. But just keep this in mind so you don't delude yourself into thinking that this is "free money."

MDM

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Re: Roth IRA or Traditional Based On My Salary
« Reply #15 on: June 30, 2015, 11:25:02 PM »
Since we're in the range for reduced deductions, I calculate (MAGI is 109031):
re-characterize all of my Roth (I had no plan at work, and earned below 181k) = 5500
Yes!  You can claim all $5500 as a deductible tIRA.

Quote
re-characterize 27.5% of DW's line 6a on the IRA deduction worksheet (she had a plan at work) = 1920
She can deduct (116000 - 109031)/(116000 - 96000) = 34.845% of $5500, rounded up to the next $10 increment.  That is $1,920, so yes again.  Note that 27.5% = $5500/($116000 - $96000), and $116000 - $109031 = $6969 is line 6a of the worksheet.  Algebra being what it is, one gets the same answer either way.

You had it correct all along.

laughing_paddler

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Re: Roth IRA or Traditional Based On My Salary
« Reply #16 on: July 01, 2015, 11:28:59 AM »
thanks Johnny847 for the heads-up on the state return, good point.

and thanks as well to MDM and dandarc for getting me thinking about this. I called the tax preparer and once I got her up to speed she agreed to file the amended returns for me as a part of the service we paid for in Feb.

now I just have to fill out the re-char forms from Vanguard...



dandarc

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Re: Roth IRA or Traditional Based On My Salary
« Reply #17 on: July 01, 2015, 11:50:47 AM »
now I just have to fill out the re-char forms from Vanguard...

Call them - seriously, they'll walk you through all of the forms online and you'll be done in like 10 minutes.

charis

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Re: Roth IRA or Traditional Based On My Salary
« Reply #18 on: July 01, 2015, 12:42:24 PM »
I did a re-char for 2014 back in January of this year.  I called Vanguard and it was very quick.