Traditional IRA vs Roth IRA vs Backdoor Roth

[EscapedApe]

According to the Investment Order (https://forum.mrmoneymustache.com/investor-alley/investment-order/) post, step 4 says that you should choose to invest in either a traditional IRA, Roth IRA, or Backdoor Roth depending on your income level.

How do you decide which investment to make? For what income levels are each investment type best suited? Are there other considerations that factor into the choice?

[EscapedApe]

To kick this off, here are the relevant IRS pages for individuals covered by a work retirement plan, and those who are not:

https://www.irs.gov/retirement-plans/plan-participant-employee/2020-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work

https://www.irs.gov/retirement-plans/plan-participant-employee/2020-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-not-covered-by-a-retirement-plan-at-work

[Scortius]

Because there's an ordered phase-out for all three, I think the rule of thumb is to use the one with the lowest threshold that you're eligible for. This means:

Traditional -> Roth -> Backdoor

This is clearly true for the Roth before Backdoor decision as they're functionally equivalent but one just takes a bit more work. Traditional is usually favored here as people expect their income to be lower in retirement, but there are always exceptions.

[terran]

The link @EscapedApe posted will tell you whether you can deduct a traditional IRA contribution. If you can, then consider https://www.bogleheads.org/wiki/Traditional_versus_Roth, if you can't then Roth is the right choice.

I suspect the second link was supposed to be https://www.irs.gov/retirement-plans/plan-participant-employee/amount-of-roth-ira-contributions-that-you-can-make-for-2020 rather than a second link to the same page. That will tell you whether you can make a direct Roth contribution. If you can, then do that, if not then see https://www.bogleheads.org/wiki/Backdoor_Roth

Here is a good link that includes links all of the IRS pages already posted as well as equivalent pages for 2019: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits.

You still have time to make 2019 contributions any time until your filing deadline for 2019, so do that as you'll have more time to contribute for 2020.

Edit: totally missed that @EscapedApe is also the OP. Good on you for doing some initial research!

[Boofinator]

Because there's an ordered phase-out for all three, I think the rule of thumb is to use the one with the lowest threshold that you're eligible for. This means:

Traditional -> Roth -> Backdoor

This is clearly true for the Roth before Backdoor decision as they're functionally equivalent but one just takes a bit more work. Traditional is usually favored here as people expect their income to be lower in retirement, but there are always exceptions.

Actually, it probably goes more like this:

Roth -> Traditional -> Roth -> Backdoor

Since if you're in the 0% tax bracket, you should almost certainly invest in a Roth.

Also, as tax rates increase, everybody will have their own calculus as to how high of a tax rate one should lock in now (using the Roth) versus an unknown tax rate many years in the future (Traditional). Most Mustachians consider it highly likely they will pay 0% on that money if they retire early or, if they work to full retirement age, a higher percent would be no big deal because they've "won the game", so the Traditional would win at even small tax rates over the Roth.

[EscapedApe]

So it seems like the general strategy is, lower your taxable income as much as possible using contributions to your 401(k) and HSA. Once that's done, look at your adjusted gross income and determine which of the next strategies you qualify for, and aim for the one with the highest potential for tax sheltering.

[MTBmustachian]

One advantage of the ROTH is that you can always withdraw your contributions to the account penalty-free. So if you want to keep less money in your emergency fund and more invested in the markets, a ROTH is a decent way to do that because you can always pull your contributions back out if you need them.

Of course, once you get to the stage that you have a healthy brokerage account, this is kind of a moot point. But in the beginning, this was a big deciding point for me.

[MDM]

So it seems like the general strategy is, lower your taxable income as much as possible using contributions to your 401(k) and HSA. Once that's done, look at your adjusted gross income and determine which of the next strategies you qualify for, and aim for the one with the highest potential for tax sheltering.

Pretty much.

One qualifier: "as much as possible" will not be correct if full HSA and traditional 401k contributions would drop you to a lower marginal rate than you expect for your eventual withdrawals.  See terran's link to the Bogleheads T vs. R wiki for more.

[EscapedApe]

So it seems like the general strategy is, lower your taxable income as much as possible using contributions to your 401(k) and HSA. Once that's done, look at your adjusted gross income and determine which of the next strategies you qualify for, and aim for the one with the highest potential for tax sheltering.

Pretty much.

One qualifier: "as much as possible" will not be correct if full HSA and traditional 401k contributions would drop you to a lower marginal rate than you expect for your eventual withdrawals.  See terran's link to the Bogleheads T vs. R wiki for more.

Good point.

I think at my current income, full contributions to HSA and 401(k) will put me at right where I want to be in terms of income during retirement, so traditional is probably still the way to go for me. I don't plan on leading an exorbitant life, now or in retirement.