IRA Madness

As long as you have enough compensation, you can always make a traditional IRA contribution -- even if it's non-deductible. If it is deductible, then of course you deduct it for the tax year you designated the contribution for. If you make a contribution between Jan 1 - Apr

-Mark Bole

IRA Contributions made prior to April 15 (tax filing deadline) can be made for current year or prior year tax filing.

My wife and I are close to going over income limits for Roth. In discussing with T Rowe Proce (where both our Roth's are held), we can contribute to a Roth, then re-charactorize to a traditional IRA after the fact if we find outselves over the income limits.

My plan is to invest in a tax deductable 401k as long as possible, then using Roth IRA to diversify this. Once we become ineligible for a Roth IRA, I plan to switch to using the Roth 401k. What is the current Roth contributions will probably be diversified into a taxable investment account.

Personally I may my 401k out before making any roth IRA contributions.

The reason, unless I'm wrong is that 401k contributions reduce your taxable income (i.e. you're investing with tax-free bucks), while roth ira contributions do not.

I admittedly don't know all the in's and outs of this, but perhaps other posters will illuminate further with more precise language. df

The Roth example is a common problem due to the income limits for a Roth

-- if you're close to the limit, you might not know until year-end whether you qualify. There are two ways of addressing it without delaying your contribution until after the end of the year. One is to make the contribution and then "recharacterize" it later, if necessary. This means "transfer the money from a Roth IRA to a Traditional IRA." Doing so turns it into a traditional IRA contribution, which may end up being nondeductible, but at least would be allowed. The other alternative is to simply take the contribution out of the Roth IRA.

The deadline for either of these alternatives is the due date of your tax return. With both you need to take out both the contribution and any earnings attributed to it. The IRS guidance discusses these things in detail - see Publication 590 at

Last point - it's important to put the year of contribution on your checks, the custodian tracks and reports this to the IRS. You can make an IRA contribution any time during the calendar year, plus the next year until April 15 (or whatever the April filing deadline is). So in that few-month window through April you can make both current- and prior-year contributions. It's especially important to note the year of contribution then because custodians will consider it "current year" unless indicated otherwise.

-Tad

True. And that's a good last-resort (especially if I get to convert it to a Roth in 2010). However, my preference would be to just make a Roth contribution now. Suppose I make a traditional contribution and later discover that I was eligible for a Roth contribution. Is there a way to go back and 'undo' the traditional contribution (other than the regular Roth conversion - we're definitely not eligible for that).

jIM wrote:

I've heard of this, and I th> Personally I may my 401k out before making any roth IRA

I favor the Roth for two main reasons. First, our taxes are already ridiculously low. I estimate that we'll pay about 6% in federal income tax this year. Next year will be a transition year, with my wife's salary going up mid-year. After that, we'll have to re-evaluate Roth vs. traditional. If our taxes go way up, it may be time to switch.

The second reason I favor the Roth is that we're only 28. It seems to me that, as the money sits and compounds, the Roth becomes a better and better deal. Since we're a long ways from retirement, the Roth seems to be a clear winner.

--Bill

I've done multiple recharacterizations (during the 2000 - 2002 bear market) and I've also removed contributions from a Roth (Tad mentioned this in his post). I did not find the paperwork for either difficult at all, but others here have disagreed and believe that the paperwork is a significant deterrent for executing this strategy. But what the heck, what's a little paperwork?

-Will

Have you asked her employer if this change will open up any deferred compensation options?

I'm looking at the same thing for 2007 - this gets tricky, because a Roth

Mark Freeland snipped-for-privacy@sbcglobal.net

If one sees the day coming where that person is not eligible for a Roth IRA, should they use the Roth 401k immediately? Meaning a person sees the day they cannot make Roth IRA contributions coming soon, within 2-3 years... so creating a Roth 401k- should it be done well in advance of losing Roth IRA eligibility, or should one take the "tax break" of a traditional 401k as long as possible?

This was the first year I had the choice of a Roth 401k. I elected not to use it... but I see the need for my Roth accounts to grow in value relative to tax deductable accounts.

For example:

Ages 34/33, Income growth is looking to reach 160k of gross salary in ~4-8 years. Current Gross Income is 110k. 70k\40k among spouses...

As I see the situation, the 85k right now is not a large enough amount to think that RMD's will put us in a higher tax bracket than we are now. But if the 401k had more in it now, it would make me think I needed to start the Roth 401k sooner.

Is their better logic to use when to start a Roth 401k? Thoughts welcome.

======================================= MODERATOR'S COMMENT: Thanks for trimming the previous post.

Here's my calculus for your situation (married, under age 50):

- If MAGI, assuming no salary reduction for contributions to Roth 401(k), is under $150K, then contribute pure Roth: $15K 401(k) + $4K (IRA) + $4K (spousal IRA).

This is because contributing $15K to a Roth is superior to contributing $15K to a traditional 401(k). See my posts in another thread showing same thing for traditional vs. Roth IRA if maxing out: news:kZ5ch.189$ snipped-for-privacy@newssvr13.news.prodigy.net or

- If you MAGI is over $175K, then go with the Roth IRA. No amount of salary reduction into a 401(k) will bring you under $160K, and $15K in the Roth 401(k) is superior to $15K in a traditional 401(k).

- If you MAGI is between $150K and $160K, contribute to the traditional

For each $2K you contribute, you reduce your MAGI by $2K, you can contribute

The tradeoff - give up $2K in Roth 401(k) for: $1.6K in Roth IRA + $2K in traditional 401(k) is a win.

- If your MAGI is over $160K, the calculations get more complicated. I'll leave that to another post.

Implicit in all of this is my belief that sheltering more outweighs subsequent unknown changes to the tax code, including unknown future tax brackets. High MRD can be dealt with by gradually converting IRAs to Roths once income drops.

Mark Freeland snipped-for-privacy@sbcglobal.net

On the flip side your taxable account with that $1k alongside the IRA is going to have some taxes year to year, so the return will be under the assumed 8% enjoyed by the Roth. It could introduce tax drag of as much as 1-2% per year.

But realistically it all gets down to the exit tax rates. Generally I don't think it's accurate to say that the Roth is necessarily superior to a traditional 401k/IRA, the comparison hinges entirely on tax assumptions. I agree that future rates may be much higher, but plenty of people are headed to a zero- or low-tax retirement. I actually just reviewed this for a retiree, where even a 10%-12% tax on Roth conversion doesn't make sense because there appears to be no likelihood of income tax in the future, on the MRDs from a Trad-IRA. The 05 and 06 federal tax rates have been 0% despite the income from the tax-deferred account. Of course not everyone is in this situation.

-Tad

Thanks for the correction. My calculations (but not conclusion :-) were wrong. For clarification, the traditional IRA nets more at time of investment, ignoring future tax liabilities, i.e. $4000 (trad IRA) + $1K (taxable) vs. $4K (post-tax Roth IRA).

Even without the drag, the traditional IRA will still net less. Suppose everything doubles in value (makes the arithmetic simple):

$8K Roth - worth $8K after withdrawal.

$8K Traditional + $2K taxable owes taxes of $2K on the IRA, and $300 on the taxable investment (assuming the lower 15% tax rate on a LTG); this nets to $7,700.

As you said, if the taxable account is bled, the return is even worse.

Agreed. All analyses (both mine and Bread's) came with the significant qualification: "all else being equal".

It's not just the MRDs. If the traditional IRA is inherited, then it will be subject to taxes at the rate of the beneficiary. (This is where a Roth conversion comes in handy - but in retirement, where the tax bracket has dropped.)

There are different approaches one can take.

- Maximize the value in the worst case (where one retires in a zero bracket). That leads one to use exclusively deductible vehicles (trad DC plans, deductible IRAs) to the extent possible (unless one is in or near a zero bracket now).

- Or one can try to maximize expected value in retirement (even to the detriment of the worst case). I agree that it depends on one's situation, though I suspect that most (not all) situations will find expected value improved by using Roth vehicles to the extent possible.

Mark Freeland snipped-for-privacy@sbcglobal.net

Current tax rates are one issue going into this. Projected RMD's and the tax bracket they are in would be another. I focus most of my attention on the RMD's and withdraw rules.

For example, the 85k I have in my tax deductable 401k is probably worth around $1,700,000 at age 70. The RMD for this is just above the $61,300 tax bracket... (RMD is $62,000)meaning I could continue using the tax deductable 401k for a little while.

If I have $450,000 in same 401k at age 45, that would be ~$3,350,000 at age 70. The RMD on this is ~$122,000, which is the next highest tax bracket.

so this implies to me, somewhere between $85k at age 33 and $450k at age 45 in 401k is when it's appropriate to convert even if income is not at threshold mentioned. This is where taxes in retirement exceed current tax bracket.

Jim, even if tax brackets remain the same it's going to be much better than that!

First, don't forget that even if the tax-bracket scheme stays exactly the same as it is right now, the dollar values of each bracket are indexed upwards every year. So today's $61,300 bracket will rise beyond $65k, $75k, (100k...), etc as the years go on. As an example the 25% bracket which starts at $61,300 in 2006 will be $63,700 in 2007, nearly a 4% increase.

The other thing to factor in is that brackets are based on taxable income, not AGI, so the tax will be lower than if based just on that MRD figure. As a baseline you might use today's standard deduction and exemption. A retiree paying medical expenses (including insurance costs), especially one with high property taxes, could be itemizing their deductions so the taxable income may be even lower.

How to estimate the impact? Perhaps an approach would be normalize it. Discount back a $1.7M IRA/401k in 20XX at some inflation rate - say, 3%

- to see what it represents in 2006 dollars. Then see what the MRDs would be today on THAT value, and take out the standard deduction & your exemptions to arrive at taxable income. It's just a WAG but it's at least a starting point that acknowledges the effect of inflation on tax brackets. For all that data on deductions, exemptions, brackets here's a great one-stop source:

-Tad

I understand that making decisions like this involves assumptions, and I know the assumptions above have assumptions which amplify other assumptions. Changing tax rates, rates of return prior to retirement, which tax bracket applies.

One not mentioned was that life expectancy should increase, so the RMD for a given principal will "decrease" over time. Unless there is something which goes into calculating/ estimating RMDs which I am not aware of.

I did like the idea of normalizing the RMD using an inflation factor, thank you.

I have limited knowledge of accounting theory... a few questions-

question on the tax tables (such as the ones at

There is a "standard deduction" which Tad included in his post above... I know this is set for married couples, and is different for single people and is different for dependants (like children). I assume the tax tables above are before this standard deduction is applied?

As Tad suggested, the tax brackets grow somewhere between 3-4% each year. Does the standard deduction change much?

I am asking so I know what to factor into calculation being discussed.

Thank You.

As the poster who frequently references Fairmark's site, I'll jump to answer this.

Fairmark shows the history for some key numbers including STD deduction and Exemptions, 2004-2006, Exemptions went up $100/yr. STD went up $150/yr, so $250 total, and Tad is right, bracket crept up a bit as well. My experience with an 80 year old

Jim, Tax tables are ALWAYS phrased in terms of taxable income, after exemptions/deductions, and yes all of these are indexed upwards each year. Though as you probably know the brackets themselves change quite a bit every now & then, with major tax legislation.

And not to complicate it too much but you don't use those tax tables if part of your income is from long-term capital gains or qualified dividend income. When you have this type of income you run through a different form on your federal return to calculate your tax.

Social Security becomes taxable if your income goes over a certain limit. See:

Also - don't forget about state taxes which are all over the map. Many don't have a special capital-gains rate, some don't tax part of your IRA/pension income, etc etc. Again, tax-prep software can handle that.

-Tad

In this situation, "pure Roth" above is really referring to the IRA portion and NOT the 401k portion, correct?

No where here did you make any assumptions for prior assetts invested. This is the sticky part for me... if I have what would be projected to around $2,000,000 in a traditional 401k at age 68 (say $1,000,000 at age 58), and assuming income won't decrease anytime soon to "convert", is their logic to suggest NOT having this much in a tax deductable account.

I see the advantages "going in"... I am more concerned with withdraw rules and timing on way out. I think this situation suggests using the Roth 401k sooner (even if MAGI is much less than 150k).

Projecting RMD's appears quite speculative to me- have to assume tax brackets, have to assume life expectancy factors, have to assume rate of returns. But we know RMD's will exist, and the goal should be keep RMD's the same tax bracket as while contributing (this tax bracket establishes standard of living/ basic costs during retirement).

The goal would be an amount in the traditional 401k/ tax deductable IRA to equal an income in current tax bracket then have rest of monies in Roth type accounts.

note to moderator, please post second response only... if possible. Trimmed more and corrected a misspelling- wish google had a spell check.