Recently “mostly fired” - continue to contribute to Roth?

[We be free if we try]

Hi,

I’m recently (mostly) fired, 51, head of household for 4 more years, and for various reasons, the nest egg is only about 25% in retirement accounts, more than half of which is Roth. I’ll still be earning about $15k / year, plus around $20k in dividends, and $20k in RMD’s, and will fill any remaining room in the 0% capital gains bucket by harvesting some long-held investments. At least, I plan to unless I figure out that the benefit is cancelled out by higher ACA premiums. (Anyone looked at this? I get that it varies based on individual numbers.)

Is there any downside to continuing to contribute to my Roth so future gains aren’t taxed? Is there a reason to continue to contribute to a traditional or SEP IRA? I’m assuming this is allowed while also taking inherited RMD’s?  It might lower my taxes now but I’m likely to have a future inheritance in 10-15 years that could significantly increase future RMD’s - having trouble gaming it out.

Thanks!

[Frankies Girl]

I am not an expert. I am just a reader that does obsess over the FIRE stuff sometimes. I state this so that you know to weight my words lightly compared to anyone of the other much more knowledgeable folks that may contradict me. I think I'm right, but do your own research to confirm, and I refer you to my signature line if someone needs to correct any of my info. ;)


The only rule I'm certain of is either you, or your spouse (if married, just throwing this out there for anyone else reading as you did say you're head of household ) must have earned income the same amount you end up contributing to any IRA. If you're FIREd but say your spouse still works and earns at least the amounts for both your and their IRA, then you can both contribute also (non-income earning spouses can always contribute as long as the income earning one makes enough to fund both theirs and spouse's IRAs).

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

Limits for this year and likely going forward:

   
$6,000 ($7,000 if you're age 50 or older), or
If less, your taxable compensation for the year

So if you're NOT married and over 50 can and have about $15K of EARNED income (not dividends/investment/RMDs - those are taxable income buckets but not applicable for this) then yes, you should be able to do either IRA's max of $7K.

Same site:

For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs.

As far as Roth or traditional (rollover) IRAs, no idea. I'd initially say go with the Roth as of right now, they do not force you to take RMDs until after the death of the owner so your heirs could be getting a chunk of change that will require them to take large distributions. But that all could change.

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions

As far as the ACA, it pays to be creative with your drawdown buckets. You can take your Roth contributions penalty free with no tax consequences I believe as long as your Roth is 5+ years old. I am on ACA and I keep a close eye on the cut offs for my area to make sure I stay in the sweet spot of the best subsidy AND cost sharing for having a silver plan. It's a very good policy that is cheaper than my workplace when I was there (and that was a very good policy also). I also have the taxable income totals so low that we stay comfortably in the 0% tax on any dividends/cap gains and am able to convert a nice chunk each year. YMMV tho.

[terran]

Yes, I would continue to contribute to Roth. Contributing to retirement accounts while withdrawing from taxable is basically an extension of the recommended investment order in that you're essentially transferring money from taxable to tax advantaged.

I'd go with Roth over traditional in your case. In fact, I'd probably go so far as to say you should convert enough traditional to Roth to fill the standard deduction if you're not already doing so as the 0% LTCG bracket is much larger than the standard deduction within which you pay 0% on ordinary income. My opinion about this might change if the amount of LTCG you'll need to realize to have enough spending money means you pay a high percentage "tax" in lost ACA subsidies.

Since you mention a SEP, if you have self employment income and no employees you could consider opening a solo 401(k). This would let you make Roth employee contributions (employer contributions are always traditional). Even if you decide you want to make some traditional contributions you'd be better off making Roth solo 401(k) contributions and traditional IRA contributions than vice versa because traditional self employed retirement plan contributions reduce your Qualified Business Income which in turn reduces your QBI deduction. E*trade is a good place to open a solo 401(k) that allows Roth contributions, or Vanguard isn't bad either.

[seattlecyclone]

At least, I plan to unless I figure out that the benefit is cancelled out by higher ACA premiums. (Anyone looked at this? I get that it varies based on individual numbers.)

Yes, I have looked at this. The phase-out of ACA subsidies acts as a parallel tax system that sits on top of the regular tax system, and you'll often lose more of a marginal dollar to your insurance than you will lose to actual income taxes. Realizing more income than you have to while on ACA insurance is therefore a suboptimal decision in many cases.

The window between age 65 and 72 (when you're on Medicare but RMDs haven't kicked in yet) is a particularly appealing place to realize a bunch of extra income. Even if this kicks you into a higher tax bracket than you're in now, it will in many cases still be less than the marginal rate you're paying now between the combination of regular taxes and ACA phase-outs. Very dependent on your individual circumstances though.

Is there any downside to continuing to contribute to my Roth so future gains aren’t taxed?

No, this is in fact a great thing. You'll pay capital gains on the current value, but any future gains will be tax-free.

Is there a reason to continue to contribute to a traditional or SEP IRA?

A reason could be to reduce your income for ACA purposes. Take a look at the marginal rates in the linked post above to consider whether you might pay less overall tax on this income later, and also take a look at whether you could get yourself below 200% of the poverty level by making these contributions. That's where the really advantageous cost sharing subsidies kick in.

One option to be aware of for a semi-retired person with a relatively low-income job is that contributions to a Roth 401(k) don't reduce your "compensation" for IRA purposes. If you earn say $15k from self-employment you could put the whole amount (minus half the self-employment tax) into a Roth solo 401(k), and you'd still be able to make full contributions to IRAs for yourself and your spouse. The IRA contributions could be either Roth or pre-tax. This 401(k) + IRA option lets you shelter a lot more than the SEP + IRA option, and could even let you shelter more than you earn.

I’m assuming this is allowed while also taking inherited RMD’s?

Yes.

It might lower my taxes now but I’m likely to have a future inheritance in 10-15 years that could significantly increase future RMD’s - having trouble gaming it out.

Yeah that could throw a wrench in things. You are aware that the rules around inherited IRAs have changed recently, correct? You are now required to remove the entire balance within ten tax years; the "stretch" option to withdraw over your remaining life expectancy is no longer available for newly inherited IRAs. Your older IRA may be grandfathered into the old rules, but a future inheritance will not be.

[terran]

@seattlecyclone while the concepts in your blog post linked above are still true, haven't the rates changed significantly (for the better) for 2021 and 2022 thanks to the most recent stimulus bill?

[seattlecyclone]

@seattlecyclone while the concepts in your blog post linked above are still true, haven't the rates changed significantly (for the better) for 2021 and 2022 thanks to the most recent stimulus bill?

The overall tax credit has increased. The marginal rates have decreased a bit for incomes below 300% of the poverty level, and increased for incomes above 300% of the poverty level. I made a new-ish post with a graph of this change.

[We be free if we try]

Wow, this is both very helpful and still a bit of a puzzle. Thanks all!

What I’m hearing is that I should fill the Roth IRA each year, and that for 2021 it may be worth setting up a Roth 401k. Due to the $15k SE income plus $20-25k RMD’s (it’s recent so spread over 10 years), I don’t have extra space in the deductible, and with another $20k in dividends, I’ll be at a minimum of 213% FPL for CA for the next few years, which means that, according to seattlecyclone’s graph, harvesting capital gains now probably doesn’t make financial sense. I have a lot of cash, to reduce SORR, so don’t need to generate gains anytime soon unless I find it financially beneficial.

Minimizing income now likely means that I’m paying more taxes in the future, but I am more sensitive to paying taxes now, since the future is uncertain, I’m still getting used to mostly-FIRE, and if I do end up inheriting later I’ll have a much fatter fire to spend with.

[seattlecyclone]

Wow, this is both very helpful and still a bit of a puzzle. Thanks all!

What I’m hearing is that I should fill the Roth IRA each year, and that for 2021 it may be worth setting up a Roth 401k. Due to the $15k SE income plus $20-25k RMD’s (it’s recent so spread over 10 years), I don’t have extra space in the deductible, and with another $20k in dividends, I’ll be at a minimum of 213% FPL for CA for the next few years, which means that, according to seattlecyclone’s graph, harvesting capital gains now probably doesn’t make financial sense. I have a lot of cash, to reduce SORR, so don’t need to generate gains anytime soon unless I find it financially beneficial.

Minimizing income now likely means that I’m paying more taxes in the future, but I am more sensitive to paying taxes now, since the future is uncertain, I’m still getting used to mostly-FIRE, and if I do end up inheriting later I’ll have a much fatter fire to spend with.

Are you aware that your health insurance premiums are eligible for a pre-AGI deduction against your self-employment income? That could push you under the 200% of FPL threshold if you haven't already factored that in. I think if you don't have to go through too many gymnastics to get under that line it's to your advantage; you'll then be able to purchase silver-level health insurance with much lower deductibles and other out-of-pocket costs.

[We be free if we try]

Good point, thanks!

[bmjohnson35]

I FIRE'd last year and I'm embarrassed to say that I never created a Roth IRA.  Since the ACA was the only health insurance option available to allow this transition, I regret not creating a Roth account sooner.  I wish I had started a Roth years ago and I definitely intend to start one this year.  Even so I can't utilize it for 5 yrs, it will still be of benefit down the road and as future income streams start to kick in, it will become even more important.  We certainly  intend to make annual contributions or rollovers to Roth going forward.

If I could go back in time to correct errors in past financial decisions, I wouldn't have bought land in TN and I would have started a Roth years ago.

[Sid Hoffman]

If I could go back in time to correct errors in past financial decisions, I wouldn't have bought land in TN and I would have started a Roth years ago.

I'm sure a lot of us would have done things differently if we'd known what we know now. That's how society gets better over time though, when older generations succeed in passing on their knowledge to the younger generations. Honestly, it's one of the things I am discouraged about though, seeing the absolutely universal hatred of older generations from younger generations. Basically we need a mole in younger generations that takes all our knowledge to the young people and pretends it was their own and didn't come from old people, that way they'll trust it is true.