Roth vs Traditional with this year's higher standard deductions

[thenewguy]

Just wanted to make sure I'm thinking about this correctly.

In deciding whether to stash money into a Roth or Traditional IRA, is this year's significantly higher standard deduction a factor? Ie, let's say my itemized deductions last year (married filing jointly) were $19,000 - a bit more than the standard deduction would have been. All else being equal, if this year I put $11,000 into Traditional IRAs, my itemized deduction would then be $30,000, correct? Maxing out Traditional IRAs last year would have increased my deduction by the full $11,000, but this year it would only increase it by about $6000. Or are IRA contributions counted differently?

Thanks!

[walkwalkwalk]

They are counted differently. IRA deduction is "above the line" vs itemized/standard deduction is "below the line". Basically they are not combined. You would have a 24k standard deduction (and assuming all 11k of your traditional was deductible - you don't indicate whether that is that case or not) and a 11k IRA deduction.

[terran]

It all comes down to marginal rate now vs marginal rate in retirement. Usually you'd want to just assume the current tax rates continue since you have no information to the contrary, but since the individual tax reform changes are set to expire in 2025, I think it would be fair to assume that the old brackets (adjusted for inflation) will come back. Don't forget to include state taxes if you expect to move to a lower/no tax state in retirement.

So broadly speaking, yes the standard deduction changes the math in that it keeps you in a lower marginal bracket at a higher income, but it still only favors Roth if you're in one of the lower brackets now and/or expect to have quite high spending in retirement. It takes around $90-100k of tax deferred withdrawals to end up in the 12% bracket or in the 15% bracket if we go back to that. Seems like plenty for a mustachian, but if you expect to spend more than that you might go into a higher bracket.

IRA contributions aren't itemized, so don't include that in figuring your itemized deduction. An $11000 IRA deduction will decrease you tax by your marginal rate whether you itemize or not.

[thenewguy]

Thanks for the quick and informative replies - very helpful!

I think I tend to be skeptical that I'll be in a lower bracket (or at least at a lower marginal rate) in retirement than now. Right now we're getting a bunch of deductions (3 young kids, mortgage interest, charitable contributions) that I expect to be gone or significantly reduced by the time retirement rolls around.

It takes around $90-100k of tax deferred withdrawals to end up in the 12% bracket or in the 15% bracket if we go back to that.

That's reassuring though.

[teen persuasion]

Look more closely at last year's itemized deductions + personal exemptions, vs this year's larger standard deduction + zero personal exemptions + larger CTC.

You can't directly compare itemized deductions of $19k to the standard deduction of $24k, because you've lost 5 personal exemptions (of roughly $4k each).  The larger CTC should offset the loss of child exemptions somewhat, but it depends on your bracket and the age of the children.

[thenewguy]

(and assuming all 11k of your traditional was deductible - you don't indicate whether that is that case or not)

That raises another question for me... I understand that there are different rules for what is and is not deductible based on whether or not my employer offers a retirement plan.

In the IRS's view, what constitutes an employer retirement plan? I'm an IT contractor. The vendor I work through does, I believe, offer a 401k but no match or pension. I get a W2 each year. That being the case, would I need to calculate how much is deductible using the rules for those with employer plans?

[walkwalkwalk]

(and assuming all 11k of your traditional was deductible - you don't indicate whether that is that case or not)

That raises another question for me... I understand that there are different rules for what is and is not deductible based on whether or not my employer offers a retirement plan.

In the IRS's view, what constitutes an employer retirement plan? I'm an IT contractor. The vendor I work through does, I believe, offer a 401k but no match or pension. I get a W2 each year. That being the case, would I need to calculate how much is deductible using the rules for those with employer plans?

If the box on your W-2 is checked (it says retirement plan) - you can check last year's W-2 if you had the same job, then you are covered by one. It sounds like you are.

In the below link you will find worksheet 1-2 to help you find your lower limit that you can deduct. There is a higher limit for Roth. Search the forum for "backdoor Roth" to find info if you're above the Roth contribution limit.

https://www.irs.gov/pub/irs-pdf/p590a.pdf

[Nothlit]

In the IRS's view, what constitutes an employer retirement plan? I'm an IT contractor. The vendor I work through does, I believe, offer a 401k but no match or pension. I get a W2 each year. That being the case, would I need to calculate how much is deductible using the rules for those with employer plans?

https://www.irs.gov/retirement-plans/are-you-covered-by-an-employers-retirement-plan

[thenewguy]

Thanks everyone!

Last year's W2 had box 13 unchecked, and nothing's changed since then. Based on the link Nothlit posted, it looks like if they offered a 401k but I didn't participate, then I'm eligible for the full deduction.

[terran]

Thanks everyone!

Last year's W2 had box 13 unchecked, and nothing's changed since then. Based on the link Nothlit posted, it looks like if they offered a 401k but I didn't participate, then I'm eligible for the full deduction.

That has been my understanding as well.

Perhaps the bigger question is why don't you contribute? Are the investment options bad?

[thenewguy]

Perhaps the bigger question is why don't you contribute? Are the investment options bad?

To be honest, I never spent much time looking into it and just assumed that it wouldn't be worth it (over just going straight to an IRA) since there's no match. I'm pretty sure I'm already well past the cutoff to enroll for next year, but maybe that's something I should look more closely at for the future?

[terran]

If you're able to save more then $12k/year (IRA limit for 2019 times two) then I would certainly look into it.

[seattlecyclone]

There's no deadline for signing up for a 401(k). You may start, stop, or modify your contribution at any time.

[thenewguy]

Thanks for all the good info!

So - hypothetically speaking if we assume that:
- I've already determined Traditional is a better option than Roth
- Employer's 401k fund options have reasonable expense ratios

If  I was looking to invest $20k in 2019, would I want to first max out the 401k ($19,000), and then the remaining $1000 in a Traditional IRA? My current understanding is that if I participate in the 401k at all (whether it's $1 or $19,000), that impacts how much of any Traditional IRA contributions are deductible - therefore if I'm going into the employer plan at all I should aim contribute up to the maximum deductible contribution.

Is that a correct understanding?

[terran]

Yes, if you're above certain income limits and you or your employer contribute to a 401(k) your IRA deduction will be limited or eliminated. If you're close to the limit, keep in mind that your 401(k) contribution can bring you back down below the limit so you may again be eligible for an IRA deduction even if you are now covered by a retirement plan at work.

[jpdx]

It all comes down to marginal rate now vs marginal rate in retirement.

While people are in the accumulation phase, I think they are more likely be taking advantage of these tax credits compared to when they retire:

Child Tax Credit
Dependent Care Credit
Savers Credit

Between the higher standard deduction and all these credits, some working families will be able to get their federal income tax close to zero. In that case, Roth makes sense, correct?

[terran]

It all comes down to marginal rate now vs marginal rate in retirement.

While people are in the accumulation phase, I think they are more likely be taking advantage of these tax credits compared to when they retire:

Child Tax Credit
Dependent Care Credit
Savers Credit

Between the higher standard deduction and all these credits, some working families will be able to get their federal income tax close to zero. In that case, Roth makes sense, correct?

Good point. you marginal bracket calculations should include credits you may be eligible for now that you won't be eligible for later.

For example, this year I'm going to be making some Roth contributions because my 199a deduction from my business income brings my marginal bracket under 10%, but I'm going to leave some of the deduction on the table because using all of it (by contributing more to Roth and less to traditional) would push me over the top saver's credit threshold meaning I'd lose that credit.

[MDM]

It all comes down to marginal rate now vs marginal rate in retirement.

While people are in the accumulation phase, I think they are more likely be taking advantage of these tax credits compared to when they retire:

Child Tax Credit
Dependent Care Credit
Savers Credit

Between the higher standard deduction and all these credits, some working families will be able to get their federal income tax close to zero. In that case, Roth makes sense, correct?

As terran noted, it's not the absolute amount of tax you pay but the marginal rate at which you would save by using traditional accounts.

If your tax bill is $0 and all your credits are and would be non-refundable, then the marginal rate is 0% and Roth makes all the sense.

But even if your tax bill is $0, if you have refundable credits (e.g., the Child Tax and Earned Income) then your marginal rate may be decidedly non-zero and traditional may still be preferable (because the tax "bill" can go negative and you get a check from the IRS).