Author Topic: Roth vs Traditional IRA  (Read 5865 times)

Gin1984

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Roth vs Traditional IRA
« on: April 03, 2014, 11:52:44 AM »
This came up in another thread and I thought I'd see everyone's opinion. 
My husband and I are both graduate students, I just moved from a Master's (Dec) to a PhD program (Mid Jan) and my husband is finishing his PhD up and moving to a post-doc in Julyish.   
I earn $25,000 a year and pay $10.39/two weeks for decent health insurance, my husband makes $26,000 and pays $36.39/2 weeks for himself and our daughter.  When he graduates they will move onto my insurance for a total of 65.10/ 2 weeks.  Because we are graduate students we don't pay FICA during the school year, only the summer.  So I can stay and finish my PhD he found a post-doc near by, well an hour drive is close by I guess.  That plus the FICA (and the increased retirement contributions) should eat up the increase in pay, because we have been a one car family until now. 
I put away $4995 in a daycare FSA and I also put 3% into a state pension pre-taxed so our gross pay this year should be about $48,750, but we also have a duplex that we rent half out and because we just replaced the roof in 2013, I think we will still take a loss or a very minimal gain.
I realized that meant we were really close to being in the 10% bracket, given the standard deduction, and the 3 personal deductions.  Depending on the house I expect to put $4000-$6000 in a traditional IRA and then the rest in a Roth.  At this point we have about $9000 in a Roth and $7000 in a traditional. 
However, the next 2 years as with my husband as a post-doc and me as a grad student will mean we are smack dab in the middle of 15%.  Even once I graduate and do a post doc myself, unless he finds a tenure track job instead of another post doc, we will be in the 15% bracket. 
But 6 years from now, if we both have decent jobs we will be in the 25% bracket and I will be maxing out the 401ks (and 457 if we have access) so I kind of want to take advantage of the Roths now.  Does this make sense to everyone?
Oh, and we don't plan to do early retirement because we plan to have a second kid at the end of grad school and pay for both private school and cash flow college so I expect to retire in 25 years (I will be 54 and my husband will be 57) as soon as college is done.

Bruno

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Re: Roth vs Traditional IRA
« Reply #1 on: April 03, 2014, 08:19:28 PM »
Ahm, sorry to lead you on the wrong track here (in case you got the unedited version), you can have IRAs.  However, you can't take the savers deduction as student.

In any case, if your husband makes the average Postdoc salary and you file jointly then he should contribute to 403b and 457 ($35k max). That should leave you with less than 50k, after exceptions and deductions you are at an extremely low tax rate - Roth territory imho. If you plan well you may know how much you need to contribute pre-tax to 403b and 457 to hit 0% tax - after that add as much as you can to Roths and -if offered- to Roth 457.
« Last Edit: April 03, 2014, 08:34:30 PM by Bruno »

Joel

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Re: Roth vs Traditional IRA
« Reply #2 on: April 03, 2014, 08:34:43 PM »
You can contribute to IRAs while you are a student, but you do not qualify for the retirement savings credit as a student.

Given the expectation of your future I comes drastically increasing and putting you at least into the 25% marginal tax bracket, you should absolutely be contributing to a Roth currently. You should not be contributing anything to a traditional IRA at your current in one level (and really while you are in the marginal 15% tax bracket)

beltim

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Re: Roth vs Traditional IRA
« Reply #3 on: April 04, 2014, 03:49:18 AM »
I mostly agree with what everyone has said.  However, a few comments:

1) The income you don't pay FICA on is not considered earned income, and so you're not able to contribute that to an IRA.  That means your max IRA contribution is the amount of earnings with FICA withdrawn, or the IRS limits, whichever is smaller.

2) In the scenario you described, the only reason to contribute to a 403b would be to take advantage on an employer match, which is pretty rare for a postdoc. 

3) The best way to figure out whether a traditional or Roth IRA is better is to figure out your expected tax rate in retirement.  If you think you'll be in the 25% bracket, or you think taxes will go up such that your marginal tax rate in retirement will be greater than 15%, then-
3a) In my mind the only reason to contribute to a traditional IRA might be to take advantage of other tax credits, like the retirement savers credit once your husband graduates.  But even then, I'd have to run the numbers to see if that would be a net benefit. 
« Last Edit: April 04, 2014, 03:56:11 AM by beltim »

Gin1984

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Re: Roth vs Traditional IRA
« Reply #4 on: April 04, 2014, 11:08:39 AM »
I mostly agree with what everyone has said.  However, a few comments:

1) The income you don't pay FICA on is not considered earned income, and so you're not able to contribute that to an IRA.  That means your max IRA contribution is the amount of earnings with FICA withdrawn, or the IRS limits, whichever is smaller.

2) In the scenario you described, the only reason to contribute to a 403b would be to take advantage on an employer match, which is pretty rare for a postdoc. 

3) The best way to figure out whether a traditional or Roth IRA is better is to figure out your expected tax rate in retirement.  If you think you'll be in the 25% bracket, or you think taxes will go up such that your marginal tax rate in retirement will be greater than 15%, then-
3a) In my mind the only reason to contribute to a traditional IRA might be to take advantage of other tax credits, like the retirement savers credit once your husband graduates.  But even then, I'd have to run the numbers to see if that would be a net benefit.
I don't think your first comment is true at all.  Why do you think it is not earned income? It comes with a W-2.

beltim

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Re: Roth vs Traditional IRA
« Reply #5 on: April 04, 2014, 12:26:14 PM »
I mostly agree with what everyone has said.  However, a few comments:

1) The income you don't pay FICA on is not considered earned income, and so you're not able to contribute that to an IRA.  That means your max IRA contribution is the amount of earnings with FICA withdrawn, or the IRS limits, whichever is smaller.
I don't think your first comment is true at all.  Why do you think it is not earned income? It comes with a W-2.

Because when I received fellowship income it was not considered earned income (I wasn't an employee) and I didn't receive a W-2.  If you get a W-2 and are considered an employee, why wouldn't they take FICA out?

Aeth

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Re: Roth vs Traditional IRA
« Reply #6 on: April 04, 2014, 12:31:20 PM »
I mostly agree with what everyone has said.  However, a few comments:

1) The income you don't pay FICA on is not considered earned income, and so you're not able to contribute that to an IRA.  That means your max IRA contribution is the amount of earnings with FICA withdrawn, or the IRS limits, whichever is smaller.
I don't think your first comment is true at all.  Why do you think it is not earned income? It comes with a W-2.

Because when I received fellowship income it was not considered earned income (I wasn't an employee) and I didn't receive a W-2.  If you get a W-2 and are considered an employee, why wouldn't they take FICA out?

They do not take out FICA because there is a Student Exemption to FICA Tax.  From the IRS website, "FICA (Social Security and Medicare) taxes do not apply to service performed by students employed by a school, college or university where the student is pursuing a course of study."

beltim

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Re: Roth vs Traditional IRA
« Reply #7 on: April 04, 2014, 12:46:11 PM »
I mostly agree with what everyone has said.  However, a few comments:

1) The income you don't pay FICA on is not considered earned income, and so you're not able to contribute that to an IRA.  That means your max IRA contribution is the amount of earnings with FICA withdrawn, or the IRS limits, whichever is smaller.
I don't think your first comment is true at all.  Why do you think it is not earned income? It comes with a W-2.

Because when I received fellowship income it was not considered earned income (I wasn't an employee) and I didn't receive a W-2.  If you get a W-2 and are considered an employee, why wouldn't they take FICA out?

They do not take out FICA because there is a Student Exemption to FICA Tax.  From the IRS website, "FICA (Social Security and Medicare) taxes do not apply to service performed by students employed by a school, college or university where the student is pursuing a course of study."

True, but I'd think that a graduate student on a stipend counts as a "professional employee" according to the IRS.  Especially one who contributes to a pension plan.

But if the university issues a W-2, you certainly have cover to consider it earned income.

Aeth

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Re: Roth vs Traditional IRA
« Reply #8 on: April 04, 2014, 12:59:45 PM »
I mostly agree with what everyone has said.  However, a few comments:

1) The income you don't pay FICA on is not considered earned income, and so you're not able to contribute that to an IRA.  That means your max IRA contribution is the amount of earnings with FICA withdrawn, or the IRS limits, whichever is smaller.
I don't think your first comment is true at all.  Why do you think it is not earned income? It comes with a W-2.

Because when I received fellowship income it was not considered earned income (I wasn't an employee) and I didn't receive a W-2.  If you get a W-2 and are considered an employee, why wouldn't they take FICA out?

They do not take out FICA because there is a Student Exemption to FICA Tax.  From the IRS website, "FICA (Social Security and Medicare) taxes do not apply to service performed by students employed by a school, college or university where the student is pursuing a course of study."

True, but I'd think that a graduate student on a stipend counts as a "professional employee" according to the IRS.  Especially one who contributes to a pension plan.

But if the university issues a W-2, you certainly have cover to consider it earned income.

I am in agreement with you with respect to the pension plan.  If they are eligible to participate in the pension plan, then they should be considered "professional employees" and not be exempt from FICA.

MDM

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Re: Roth vs Traditional IRA
« Reply #9 on: April 04, 2014, 01:21:32 PM »
When in doubt, read the (IRS) instructions: http://www.irs.gov/publications/p970/ch01.html

"1.   Scholarships, Fellowships, Grants, and Tuition Reductions
...
Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. Under this rule, a taxable scholarship or fellowship is compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement. "

See also http://www.mrmoneymustache.com/forum/ask-a-mustachian/don't-qualify-for-an-ira-what-now/msg49899/#msg49899 and http://www.evolvingpf.com/2012/03/earned-income/


seattlecyclone

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Re: Roth vs Traditional IRA
« Reply #10 on: April 04, 2014, 01:37:22 PM »
One thing about the saver's credit: only full-time students are prohibited from taking the credit. When I was in grad school, the university considered me a 75% time student based on the number of courses I was taking, and a 50% time employee for my teaching assistantship. This adds up to 125%, which if anything was a bit of an understatement. You should check with your university to see how many credit hours you need to sign up for to be considered a full-time student. If you're below that threshold, you could be eligible for the saver's credit.

beltim

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Re: Roth vs Traditional IRA
« Reply #11 on: April 04, 2014, 01:39:39 PM »
One thing about the saver's credit: only full-time students are prohibited from taking the credit. When I was in grad school, the university considered me a 75% time student based on the number of courses I was taking, and a 50% time employee for my teaching assistantship. This adds up to 125%, which if anything was a bit of an understatement. You should check with your university to see how many credit hours you need to sign up for to be considered a full-time student. If you're below that threshold, you could be eligible for the saver's credit.

That's a classification I hadn't seen before.  Curiouser and curiouser.  Good addition!

Gin1984

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Re: Roth vs Traditional IRA
« Reply #12 on: April 04, 2014, 01:45:22 PM »
One thing about the saver's credit: only full-time students are prohibited from taking the credit. When I was in grad school, the university considered me a 75% time student based on the number of courses I was taking, and a 50% time employee for my teaching assistantship. This adds up to 125%, which if anything was a bit of an understatement. You should check with your university to see how many credit hours you need to sign up for to be considered a full-time student. If you're below that threshold, you could be eligible for the saver's credit.
We are required to be full time students to get our stipends and tuition wavers.

seattlecyclone

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Re: Roth vs Traditional IRA
« Reply #13 on: April 04, 2014, 01:51:44 PM »
One thing about the saver's credit: only full-time students are prohibited from taking the credit. When I was in grad school, the university considered me a 75% time student based on the number of courses I was taking, and a 50% time employee for my teaching assistantship. This adds up to 125%, which if anything was a bit of an understatement. You should check with your university to see how many credit hours you need to sign up for to be considered a full-time student. If you're below that threshold, you could be eligible for the saver's credit.
We are required to be full time students to get our stipends and tuition wavers.

Okay, just thought I'd mention it. Every university is different. My university set full-time status at eight credit hours per semester, and our department strongly advised teaching assistants not to sign up for more than two courses (six credits).