Author Topic: Super low income. Should I begin with a taxed account?  (Read 2521 times)

jgarland5428

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Super low income. Should I begin with a taxed account?
« on: May 23, 2017, 12:19:20 AM »
About to be out of school. Art degree. Intent on being self-employed.
Looks like I'll be scraping on 1500 a month, with 15% going to investments to start. I haven't made it to other side yet, so I can't be sure of these numbers.
With these prospects for the foreseeable future, is it still best to open a 401k, then IRA, then taxed account? Or should I begin with a taxed account and then open a 401k and IRA once my income becomes more cushion-y? I'm thinking that my priority should be in something I can withdraw from, but perhaps this is myopic.
In other words, when is it a good idea to open a taxed account before 401k/IRA, if ever?
« Last Edit: May 23, 2017, 12:23:40 AM by jgarland5428 »

Monkey Uncle

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Re: Super low income. Should I begin with a taxed account?
« Reply #1 on: May 23, 2017, 04:43:58 AM »
If you get an employer match on the 401k, it is always best to fund your 401k first, up to the point that you max out the match.  No sense in turning down free money.

For a low income person, I would focus on a Roth IRA second.  You won't be paying much in taxes now anyway, so I would say take advantage of the opportunity to fund an account that won't be taxed when you withdraw (when you most likely will be in a higher tax bracket).

If you still have any money left to invest after those two steps, it gets a little murkier.  Right now a "taxable" account won't generate any taxes if you invest in products that generate qualified dividends and long-term capital gains (because your income is low enough that the dividends and gains are taxed at a 0% rate).  So you get tax-free growth without any restrictions on the money.  But you don't get a tax deduction on the amount you invest.  And eventually your income may be high enough that the gains and dividends no longer fall within the 0% tax bracket.  But you have to try to balance that against the tax deduction you would get now for investing in the tIRA, and the regular income tax rate you will pay when you withdraw from the tIRA. 

A while back someone on here posted some ordering rules for the various types of accounts.  I don't remember where to find it, though.  Hopefully someone else will link to it.

SeattleCPA

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Re: Super low income. Should I begin with a taxed account?
« Reply #2 on: May 23, 2017, 06:43:24 AM »
If you get an employer match on the 401k, it is always best to fund your 401k first, up to the point that you max out the match.  No sense in turning down free money.

For a low income person, I would focus on a Roth IRA second.  You won't be paying much in taxes now anyway, so I would say take advantage of the opportunity to fund an account that won't be taxed when you withdraw (when you most likely will be in a higher tax bracket).

If you still have any money left to invest after those two steps, it gets a little murkier.  Right now a "taxable" account won't generate any taxes if you invest in products that generate qualified dividends and long-term capital gains (because your income is low enough that the dividends and gains are taxed at a 0% rate).  So you get tax-free growth without any restrictions on the money.  But you don't get a tax deduction on the amount you invest.  And eventually your income may be high enough that the gains and dividends no longer fall within the 0% tax bracket.  But you have to try to balance that against the tax deduction you would get now for investing in the tIRA, and the regular income tax rate you will pay when you withdraw from the tIRA. 

A while back someone on here posted some ordering rules for the various types of accounts.  I don't remember where to find it, though.  Hopefully someone else will link to it.

+1

SeattleCPA

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Re: Super low income. Should I begin with a taxed account?
« Reply #3 on: May 23, 2017, 06:43:45 AM »
If you are going to be self employed and scraping by on 1500 per month, I'd suggest first working on saving up a sufficient emergency fund. Save this in a high interest savings account like at Ally Bank or CapitalOne 360.

Usually a 401K would be through an employer.  So, I'm not sure you could open one yourself. 

If your are intent on setting up a retirement savings account, it might be a good idea for you to look at the myRA Account until you have enough saved to buy the minimum for a an investment in a mutual fund in an IRA.  The current interest rate at the myRA is about 2% and you cannot loose money in it.  The myRA can be rolled over to a Roth IRA later.

You can always withdraw your contributions from a Roth IRA without penalty.  Any gains would be subject to a penalty on withdrawal if the withdrawal does not fall under a qualified exception.

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DavidAnnArbor

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Re: Super low income. Should I begin with a taxed account?
« Reply #4 on: May 23, 2017, 07:30:30 AM »
Putting money in a traditional IRA while you are low income enables you to likely qualify for the "Savers Tax Credit."  That is free money and you don't want to pass up on that.

nereo

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Re: Super low income. Should I begin with a taxed account?
« Reply #5 on: May 23, 2017, 07:34:45 AM »
Putting money in a traditional IRA while you are low income enables you to likely qualify for the "Savers Tax Credit."  That is free money and you don't want to pass up on that.

I would do this.  Next year (assuming your financial situation has not improved) you can start a Roth Pipeline, moving your 2017 contributions from tIRA into a Roth.  You'll qualify for the Savers Tax Credit, pay little/no tax on your pipeline and you'll never pay tax on your Roth.
(see below)
« Last Edit: May 23, 2017, 07:52:23 AM by nereo »

Cpa Cat

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Re: Super low income. Should I begin with a taxed account?
« Reply #6 on: May 23, 2017, 07:45:57 AM »
Putting money in a traditional IRA while you are low income enables you to likely qualify for the "Savers Tax Credit."  That is free money and you don't want to pass up on that.

I would do this.  Next year (assuming your financial situation has not improved) you can start a Roth Pipeline, moving your 2017 contributions from tIRA into a Roth.  You'll qualify for the Savers Tax Credit, pay little/no tax on your pipeline and you'll never pay tax on your Roth.

Saver's Credit applies to ROTH contributions. There is absolutely no reason to do somersaults through a traditional IRA in this situation.

The order is this:

1. 401(k) only up to employer's match (if there even is one). Do ROTH 401(k) contributions if available.
2. ROTH IRA until maxed.
3. ROTH 401(k) if available or taxable. If your income rises, then consider traditional 401(k).

Saver's Credit is available on ALL retirement contributions - 401(k), ROTH, traditional, and the whole host of other plans (403(b), 457, SEP, etc).

A note on ROTH IRA vs ROTH 401(k) - if you open your own fee-free ROTH at Vanguard or Fidelity or somewhere and invest in super low cost index funds then you are probably better off than going with whatever your employer offers in a ROTH 401(k) - but if your employer offers great 401(k) options and the option to do ROTH contributions, then there's really no preference. If your friend who works at Edward Jones is who you'd open the ROTH IRA with, then stick with your employer's ROTH 401(k) if available.
« Last Edit: May 23, 2017, 07:49:46 AM by Cpa Cat »

nereo

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Re: Super low income. Should I begin with a taxed account?
« Reply #7 on: May 23, 2017, 07:52:02 AM »
seems you're right.  Thanks for the correction cpa cat.

ysette9

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Re: Super low income. Should I begin with a taxed account?
« Reply #8 on: May 23, 2017, 07:53:22 AM »
https://forum.mrmoneymustache.com/investor-alley/investment-order/

This is the thread you want to read about where to put your money in what order, and why.

Gin1984

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Re: Super low income. Should I begin with a taxed account?
« Reply #9 on: May 23, 2017, 08:32:59 AM »
Putting money in a traditional IRA while you are low income enables you to likely qualify for the "Savers Tax Credit."  That is free money and you don't want to pass up on that.
You can get the saver's credit with a Roth or traditional IRA, if your income is low enough and you are not a student.

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DavidAnnArbor

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Re: Super low income. Should I begin with a taxed account?
« Reply #10 on: May 23, 2017, 12:51:17 PM »
So when you do your taxes you'll be able to see what your AGI income is and decide if you need to lower it more through the use of a solo 401k plan, and/or traditional ira in order to insure you can get the tax savers tax credit.