Author Topic: Switch from Roth to Traditional IRA  (Read 1628 times)

ChpBstrd

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Switch from Roth to Traditional IRA
« on: April 07, 2017, 09:02:50 PM »
$134,500 earned income
$74,800 taxable income
Married filing jointly
Paid about $9k in taxes last year

Each year we max out two 401(k)s at $18k each. Then we max out our Roth IRAs at $5,500 each. We also do FSAs. Then we can usually stash away a couple thousand taxable.
Our investments are about $500k total. About $65k of that is in a plain taxable brokerage account, our two Roths are worth about $65k each, and the rest is pretax. Our FIRE number is $1.25 million (4% rule applied to $50k annual spending). I'm looking at hitting that number in 6 years.

I've read the Investment Order post. I'm just looking for confirmation of my suspicion that we should be maxing out Traditional IRAs instead of Roth IRAs.

First, we were ~$500 in AGI away from hitting the 25% tax bracket last year, so any raise is likely to push us over that edge in 2017. Back in the days when our current 15% tax bracket equaled our retirement tax bracket, I saw pre/post tax as being a wash, and chose to insure against higher tax rates. Now, however, our income is higher, so the higher rates are here and now.

Second, I'm seeing that $9k tax bill and asking whether deferring 15% of $11,000 ($1,650) is like a free loan for as many years (decades?) as I want to keep it and invest it. Yes please.

Third, I'm studying the Roth IRA ladder approach to withdrawing pretax funds before normal retirement age. In 6 years, we may be perfectly set up to live off the existing money in the Roths for 5 years while we build that ladder. So if we stopped Roth contributions now, and it grows from $130k to, say, $200-230k at FIRE time, we're set for those first 5 years of retirement at a $45-50k burn rate.

So please let me know if you agree with this change to our approach!

Also, I had this realization AFTER maxing our Roths for 2017. Is undoing that action as simple as just transferring the funds from the Roths to traditional IRAs?
« Last Edit: April 08, 2017, 11:24:27 AM by ChpBstrd »

MDM

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Re: Switch from Roth to Traditional IRA
« Reply #1 on: April 07, 2017, 10:42:35 PM »
$134,500 earned income
$74,800 AGI
Married filing jointly
...
First, we were ~$500 in AGI away from hitting the 25% tax bracket last year, so any raise is likely to push us over that edge in 2017.

At a quick glance your reasoning seems sound, but one question: is that $74,800 your Adjusted Gross Income (line 37/38 of Form 1040), or Taxable Income (line 43 of Form 1040)?

prettypaperwork

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Re: Switch from Roth to Traditional IRA
« Reply #2 on: April 07, 2017, 10:48:31 PM »
Recharacterizing Roth contributions to traditional is fairly simple if you have the Roth and traditional IRA accounts at the same company (it's probably not a biggie if you don't).  And why stop at recharaterizing 2017's contributions? You have until October 2017 to recharacterize your 2016 contributions.  And then you get to file an amended return for 2016.  And then our good old Uncle Sam sends you a pretty check via USPS WITH accrued interest!  Win, win, win all around!

mizzourah2006

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Re: Switch from Roth to Traditional IRA
« Reply #3 on: April 08, 2017, 07:40:00 AM »
$134,500 earned income
$74,800 AGI
Married filing jointly
...
First, we were ~$500 in AGI away from hitting the 25% tax bracket last year, so any raise is likely to push us over that edge in 2017.

At a quick glance your reasoning seems sound, but one question: is that $74,800 your Adjusted Gross Income (line 37/38 of Form 1040), or Taxable Income (line 43 of Form 1040)?

Yeah, that AGI seems really low unless you have access to something additional like a 457. Typical would be gross minus 401k minus HSA, but either way if your MAGI is below $108k you can take the full deductions. We have been right around that Point for the last 2 years and we recharacterize as much as we can for the same reasons OP mentioned. A conversion ladder at a later point.

DavidAnnArbor

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Re: Switch from Roth to Traditional IRA
« Reply #4 on: April 08, 2017, 08:46:59 AM »
You should definitely recharacterize 2016 and 2017 from Roth to Traditional.

Since mine is with Vanguard, I did that a while ago to benefit my 2016 tax return.

It looks to me like your marginal tax rate while working is 25% while your retirement marginal tax rate will be 15%

teen persuasion

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Re: Switch from Roth to Traditional IRA
« Reply #5 on: April 08, 2017, 09:02:47 AM »
Just so you are clear, you can withdraw Roth IRA contributions tax and penalty free, but not earnings (before age 59 1/2).  So to live on Roth withdrawals, it is your contribution totals that matter, not total balance.

However, you can also use taxable withdrawals for living expenses for the first 5 years setup period.
« Last Edit: April 08, 2017, 09:05:28 AM by teen persuasion »

ChpBstrd

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Re: Switch from Roth to Traditional IRA
« Reply #6 on: April 08, 2017, 11:25:43 AM »
$134,500 earned income
$74,800 AGI
Married filing jointly
...
First, we were ~$500 in AGI away from hitting the 25% tax bracket last year, so any raise is likely to push us over that edge in 2017.

At a quick glance your reasoning seems sound, but one question: is that $74,800 your Adjusted Gross Income (line 37/38 of Form 1040), or Taxable Income (line 43 of Form 1040)?

Good eye. Taxable income.

Also I did not mention pretax benefit and FSA deductions.

MDM

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Re: Switch from Roth to Traditional IRA
« Reply #7 on: April 08, 2017, 01:50:58 PM »
$134,500 earned income
$74,800 AGI
Married filing jointly
...
First, we were ~$500 in AGI away from hitting the 25% tax bracket last year, so any raise is likely to push us over that edge in 2017.

At a quick glance your reasoning seems sound, but one question: is that $74,800 your Adjusted Gross Income (line 37/38 of Form 1040), or Taxable Income (line 43 of Form 1040)?

Good eye. Taxable income.

Also I did not mention pretax benefit and FSA deductions.

In that case, you might save slightly less than 15% using tIRAs, due to lower state tax deduction when you itemize.  You could verify that using commercial tax software (or by hand), or make a quick estimate using the case study spreadsheet.

E.g., below are some guesses that more or less approximate your situation, and lead to the "slightly less than 15%" conclusion.  In that case, it's likely close to a coin flip regarding T vs. R.  If you can save ~25%, then traditional should be better.

CategoryMonthly
Comments
Annual
Salary/Wages for earner #1$5,604$67,250
Salary/Wages for earner #2$5,604$67,250
Pretax Health Ins.$500$6,000
Healthcare Flex Savings Acct. (FSA)$150$1,800
FICA base salary/wages$10,558$126,700
401(k) / 403(b) / TSP / etc.$3,000At maximum$36,000
Income subject to IRS tax$7,558$90,700
Schedule C net profit$917$11,000
Federal Total Income$8,475$101,700
Federal tax$8552017 rates, MFJ, item. ded., 2 exempt.$10,258
State/City tax$390Guess, using 5.00% * (AGI - Exempt'n)$4,680
Soc. Sec.$655Assumes 2 earners paying$7,855
Medicare$153$1,837
Self-employment Tax$130$1,554
Total income taxes$2,182$26,185
Add Health + Daycare reimb.$150$1,800
Income before other expenses  $6,443$77,315
Monthly Average Expenses:
Mortgage$1,389Input to Itemized Deductions$16,672
Property Tax$200Input to Itemized Deductions$2,400


Filing Status21=S, 2=MFJ, 3=HOH
# Exemptions2
Adult #1Adult #2
Age4949
# of earners2
Total Income$101,700
Std. Deduct.$12,700
Act. Deduct.$18,218
Exemption$8,100
Deductible SE tax$777
AGI$100,923
MAGI$100,923
Taxable$74,605
1040 Tax$10,258
Tax after n-r credit$10,258
Net Tax$10,258
Monthly$855
Mtg. Int. (approx.)$11,138
State tax$4,6805.00%
Prop tax$2,400
Item. Deduct.$18,218
VersionV8.16

Loans:Orig. Prin.Orig. LengthCurr. Prin.Yrs leftRate
Mortgage$300,00030$300,000303.750%

ChpBstrd

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Re: Switch from Roth to Traditional IRA
« Reply #8 on: April 09, 2017, 11:45:19 AM »
$134,500 earned income
$74,800 AGI
Married filing jointly
...
First, we were ~$500 in AGI away from hitting the 25% tax bracket last year, so any raise is likely to push us over that edge in 2017.

At a quick glance your reasoning seems sound, but one question: is that $74,800 your Adjusted Gross Income (line 37/38 of Form 1040), or Taxable Income (line 43 of Form 1040)?

Good eye. Taxable income.

Also I did not mention pretax benefit and FSA deductions.

In that case, you might save slightly less than 15% using tIRAs, due to lower state tax deduction when you itemize.  You could verify that using commercial tax software (or by hand), or make a quick estimate using the case study spreadsheet.

E.g., below are some guesses that more or less approximate your situation, and lead to the "slightly less than 15%" conclusion.  In that case, it's likely close to a coin flip regarding T vs. R.  If you can save ~25%, then traditional should be better.

CategoryMonthly
Comments
Annual
Salary/Wages for earner #1$5,604$67,250
Salary/Wages for earner #2$5,604$67,250
Pretax Health Ins.$500$6,000
Healthcare Flex Savings Acct. (FSA)$150$1,800
FICA base salary/wages$10,558$126,700
401(k) / 403(b) / TSP / etc.$3,000At maximum$36,000
Income subject to IRS tax$7,558$90,700
Schedule C net profit$917$11,000
Federal Total Income$8,475$101,700
Federal tax$8552017 rates, MFJ, item. ded., 2 exempt.$10,258
State/City tax$390Guess, using 5.00% * (AGI - Exempt'n)$4,680
Soc. Sec.$655Assumes 2 earners paying$7,855
Medicare$153$1,837
Self-employment Tax$130$1,554
Total income taxes$2,182$26,185
Add Health + Daycare reimb.$150$1,800
Income before other expenses  $6,443$77,315
Monthly Average Expenses:
Mortgage$1,389Input to Itemized Deductions$16,672
Property Tax$200Input to Itemized Deductions$2,400


Filing Status21=S, 2=MFJ, 3=HOH
# Exemptions2
Adult #1Adult #2
Age4949
# of earners2
Total Income$101,700
Std. Deduct.$12,700
Act. Deduct.$18,218
Exemption$8,100
Deductible SE tax$777
AGI$100,923
MAGI$100,923
Taxable$74,605
1040 Tax$10,258
Tax after n-r credit$10,258
Net Tax$10,258
Monthly$855
Mtg. Int. (approx.)$11,138
State tax$4,6805.00%
Prop tax$2,400
Item. Deduct.$18,218
VersionV8.16

Loans:Orig. Prin.Orig. LengthCurr. Prin.Yrs leftRate
Mortgage$300,00030$300,000303.750%

Wow! Great work MDM. The main difference between my case and the numbers you plugged in as assumptions is that my mortgage interest deduction is only about $5k. In fact, I've taken the standard deduction for at least the past 5 years, despite charitable donations and similar. And it's not even close.

Also, we max out a dependent care FSA and send another $1k to a medical FSA.

I'm thinking the move to tIRA makes sense even if I can't pin down the exact savings. After all, in the race to FIRE, this strategy would hit my number sooner. Maybe if I had a huge Roth hoard, I could lower my FIRE number to account for taxes I won't have to pay, but I think earning returns on the taxes I'll eventually pay sounds better in the meantime.


MDM

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Re: Switch from Roth to Traditional IRA
« Reply #9 on: April 09, 2017, 02:31:42 PM »
The main difference between my case and the numbers you plugged in as assumptions is that my mortgage interest deduction is only about $5k.
...
Also, we max out a dependent care FSA and send another $1k to a medical FSA.
Ok, that (having an extra exemption and deducting the FSA) explains things well.

Quote
I'm thinking the move to tIRA makes sense even if I can't pin down the exact savings. After all, in the race to FIRE, this strategy would hit my number sooner. Maybe if I had a huge Roth hoard, I could lower my FIRE number to account for taxes I won't have to pay, but I think earning returns on the taxes I'll eventually pay sounds better in the meantime.
If you have to err, erring on the side of "too much traditional" is better.  I do encourage you at least to try the spreadsheet that generated the table, using your real numbers.  Might not be exact, but it's usually pretty close....