I opened a ROTH and traditioanl IRA a few years ago and put $1500 into each per year. I really did not know anything about these IRA's and just opened them because the financial adivisor said buzzwords like 'tax-free'.
Now I am reading that the only benefit of opening a ROTH is so you can deduct the contributions from your taxes. However for the past few years I have always taken the standard deduction since my itemized deductions where never enough.
DOes this mean I should have never opened a ROTH IRA?
Where the heck did you read that? It's totally incorrect.
Roth IRA contributions are post-tax. There is no deduction there. The win is that you don't have to pay taxes on dividends and capital gains when you withdraw the money from the Roth; with the effects of compounding over many years, this is a big savings.
There is a tax write-off for contributions to a Traditional IRA, as opposed to a Roth, but the deduction appears on a totally different place on the tax form than lumped in with itemized deductions. With a Traditional IRA, your contributions are pre-tax, but when you withdraw the money, you have to pay regular income tax rates on everything.
For most folks, the Roth is a better deal than a Traditional IRA; in part because the contribution limits are the same for both, but the Roth IRA funds being post-tax means they are "denser". I'd encourage you to (a) find some reliable sources of information to read and (b) max out your Roth contributions each year.
I can't help you with (b) ;-) but for (a) I suggest you visit any of the major financial planning web sites -- morningstar.com has tutorial material about a lot of investment and financial planning topics, for instance.
I think it's smart to have both types of IRA's, assuming the contributions to the traditional IRA are deductible. I'm pretty sure Congress will eventually figure out a way to tax Roth IRA distributions. There's no way they'll let baby boomers take that much money off the table taxfree. Probably not directly, but they will reduce your SS benefits, or perhaps the whole existing tax system will be scrapped and we'll go to a national sales tax or something. They'll call it a "fair tax." At least you will have gotten the up front tax savings on the traditional IRA.
Both the traditional and Roth will have grown over the years without any tax burden, and the Roth contributions are still accessible without penalty in an emergency, so it's still a good deal.
Actually my AGI ( Adjusted Gross Income )is too high for me to deduct any portion of my Traditioanal IRA contributions. Can I now max out my Roth IRA or does it have rules depending on your income and on whether your 401k is already maxed out?
The Roth IRA has its own rules and limits, independent of your 401k. Well, not really independent because maxing out your 401k might lower your AGI enough to allow you to contribute to a Roth IRA?. I'll let someone who actually knows what they are talking about answer that :-) My income is low enough that I can fully fund a Roth IRA, but I'm not sure where the cutoff is.
All my new IRA money goes into a Roth IRA. I also have a traditional IRA that I set up many years ago, but I don't want to contaminate it with any nondeductible contributions.
This is the point I am confused on. I don't recall ever having filled out an IRS Form 8606? Is this entirely my responsibilty or is it autommatically done by the fund company I invested my Traditional IRA in?
Bear in mind that "contaminate" applies to the collective sume of all your traditional IRA accounts. If you have an account which was funded from only regular deductible contributions and try to keep it "uncontaminated" by opening a new IRA account for non-deductible traditional IRA contributions, it just doesn't work that way - regardless of which account you eventually take money out from, it affects your basis and you have to track it all with your 8606 forms.
I suspect you already know this, but for anyone else out there who might consider trying to keep deductible and non-deductible traditional IRA contributions separate, well, you can't.
Do I also file 8606 for my contributions to Roth IRA? Why can't the IRA funds automatically keep track of what you put in? I wonder how many IRA owners are aware of all this, as I clearly was not. This would make for a good 60-minutes report!
1) No forced withdrawal of money at any age because the government has all the taxes it will collect already.
2) "Interest on interest" is never taxed as in most other deferred income accounts. This effect become significant after 20 years or so.
Add a third one, which can be of huge importance for retired folks: Roth IRA distributions do not contribute to the taxability of Social Security benefits.
I don't understand why this is relevant, as the initial principal has already been reduced by the tax paid on it when you deposited it.
Consider two scenarios:
A) You deposit money in a traditional IRA, wait some period of time, and then withdraw the money, paying taxes on it at that time.
B) You pay taxes on money, deposit what's left in a Roth IRA, wait some period of time, and then withdraw the money, paying no further taxes.
I claim that if the tax rates are the same, and the accounts' earnings are the same over the same period of time, then what you have after the withdrawal and paying any taxes dur on the withdrawal will be the same in both scenarios.
If you think I am missing something, please tell me what it is.
It's called the Commutative property of multiplication: P*G*T = P*T*G P=principal, G= growth, T= taxrate So I agree with you.
The point others bring up is more toward 'density'. You can only put $4000 into the IRA, so if it's tax deductible, where does the $1000 refund go (assuming 25% bracket)? Into a taxable account, I'd assume. By putting the $4000 into the Roth, you avoid that. JOE
Um, yeah. I do think it's remarkable, though, how many people don't get this point.
Agreed. Again, this is a point that many people seem to miss: Putting money into a Roth is *not* equivalent to putting the same amount into a traditional IRA.
The 8606 tracks the amount of your contributions to a traditional IRA which were non-deductible. The fund company does not know if/whether you deducted the contributions or not - your ability to deduct them depend on your income level, whether you have a 401k at work, etc - things outside the fund company's knowledge and control.
The 8606 and "basis" tracking for your non-deductible traditional IRA contributions is your responsibility.
There's also a notion of "tax diversification" - you don't know whether your marginal rate will be higher or lower when you retire, so to reduce risk, having some money in a Roth (already taxed at today's rate) and some in a traditional (all of which will be taxed at a future rate), you split that exposure.
In general I agree with you here, but as I run the numbers I wonder how high the risk is, of saving your way into a higher bracket at retirement.
Consider, for a couple, the Exemptions ($3400 each) and Standard Deduction ($10,700) combine with the top of the 15% bracket ($63,700) to total $81,200 one can withdraw at retirement and still be in the 15% bracket. Given our rule of 25, this is the sum withdrawn from a pre-tax savings of $2.03M. But let's circle back. $81K is what someone earning well over $100,000 would target as an annual withdrawal, right? Even ignoring SS, once you account for taxes and the savings, 80 is take home for 120K gross give or take. I'd be curious to hear others' views on this, but I'm thinking it would take either a super saver, working well beyond their 'need' for money, or someone fortunate enough to have superior investment returns to land in a higher bracket. My analysis shows it more likely to be two brackets lower in retirement, and it would take quite a change in tax structure to trip that up. JOE
It is not a good idea to ignore Social Security benefits. Don't forget that, for some income ranges, an additional $1 of income causes not only that $1 to be taxed, but also $0.50 or $0.85 of Social Security benefits to be taxed. So someone whose income level would put them into the 15% bracket can find themselves with a marginal tax rate of
22.5% or 27.75%. And this occurs at a lot lower income than where the
25% bracket kicks in. If you are in the 15% tax bracket before retiring, and think you will fall in the income range where Social Security taxation creates these higher rates, then you should seriously consider contributions to a Roth, or even IRA to Roth IRA conversions to "top up" your 15% bracket.
and then for this thread, ignored my own wisdom. The third page of my article shows the impact of income for a couple receiving $25K in SS benefits. If my math is right,
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tells me that $12.5K is the benefit someone with an ending pay of $23,600 would have earned. So if the couple had similar incomes, they made $47,200, and will receive the $25K SS. They need to make up $20K or less, and from my chart, they only get nailed after $29.5K of pre-tax money withdrawn.One would need nearly $738K to suggest a withdrawal of that $29.5K. So, drop back 20 years, this couple had little to worry about from saving too much or from the SS tax bubble. Of course, if they saved the
20X final pay we discuss, they'd have $944K and hit that bubble dead on. In the end, you are right, it was foolish of me to dismiss my own observations. Some more time in excel and TurboTax will help me narrow down advice to better define the range of people this would impact. For a single retiree, that bubble isn't just 27.75%, it's 46.25%. Good to stay out of that trap.
You may be right in most instances. But if we use the example you gave, I think our saver will end up in the same tax bracket (if by some crazy chance the tax brackets remain the same in current dollars). For a 120k groos, take home could be around 80k as you suggest. If all of our saver's money is in pre-tax accounts, then it would take ~91.3k to keep that equivalent 80k take home, leaving our saver in the 25% bracket. So our saver will be better off in a Roth if that bracket's rate moves up (which it looks like will happen in 2010 - but out farther than that, who knows?). Of course, every dollar that comes out of a Roth (or maybe even a taxable) vehicle gets our saver closer to the next bracket down. So it seems that tax diversification would be wise. Maybe?
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