Review our portfolio - young family (updates from Newlywed!)

[sksavers2]

Hi Bogleheads! We got great advice from this group 5 years ago, when our situation was quite different (newlywed DINKS! viewtopic.php?f=1&t=14328) A couple of years ago, we hit big financial milestone and wanted opinions about whether we could stop aggressively saving for retirement so that DH could quit a job he hated (viewtopic.php?f=1&t=53654). We now have 2 young kids, have mostly implemented the plan we came up with a few years ago, and DH took a 30% pay cut for a job that he finds more fulfilling (although still stressful). My job now provides about 30% of our family income, so our income has basically stayed the same. We live in one of the highest cost-of-living areas in the country and the cost of childcare is nearly my take-home salary, so we are not living as frugally as before. I thought it was time to have another go at some outside perspective on how we’re doing and what changes we might make at this stage.

Wife Age: 35
Husband Age: 44
2 kids, ages 1 and 3 (and…we’re 90% sure we’re done!)

Debt:
Mortgage on principal home (380k @ 4.75 fixed)
Mortgage on rental property (85k @ 2.5 ARM, resets yearly; has decreased annually for 3 yrs; planning to sell this property in 2013)

Size of the portfolio: approx 1.1 million
Filing status: married filing jointly
Federal tax rate: 33%
State tax rate: 5.25% plus County Tax 3.2%

Desired allocation (61% stock/39% bond/cash)
18% int’l stock
35% domestic stock
8% company stock (if it were a fund, it would be a balanced global fund – good dividend, very diversified industries, very diversified internationally)
17% bonds
17% TIPS bonds
5% cash for investing and rebalancing
* Other cash is not included here (9 month efund and miscellaneous short- and medium-term savings)

His 401K with current employer (44.5% of total portfolio)
23.9% Vanguard Institutional Index S&P500 (VIIIX) (0.02%) 5*
22% Vanguard Total Bond Market Index (VBMPX) (0.05%) 3*
6.4% Vanguard Small Cap Index Institutional (VSCIX) (0.12%) 4*
4.4% Vanguard Prime Money Market Fund (VMRXX) (0.12%)

Company match is being maxed out.

Her Roth IRA with Vanguard (5.2% of total portfolio)
5.2% Vanguard TIPS (VAIPX) (0.11%)

Her Rollover IRA with Vanguard (10.2% of total portfolio) – rolled over 401k from former company
10.2% Vanguard TIPS (VAIPX) (0.11%)

His Roth IRA with Vanguard (2.9% of total portfolio)
2.9% Vanguard TIPS (VIPSX) (0.15%)

Taxable (40.1% of total portfolio)
11.6% - Vanguard Total Stock Market Admiral (VTSAX) (0.06%)
10.3% - Vanguard FTSE Ex-US Index Admiral (VTIAX) (0.18%)
13.6% - Employer Stock – international, diversified professional services organization (ESPP at 15% discount; purchased 10% of income since 2001 and have sold sporadically. Trying to convince husband to cut this down to 8%...but hard to convince when the stock has outperformed all other investments annually.)

Total of Entire Portfolio is 100%

New annual contributions
$24,200 His 401(k) (including matching contributions)
$5,000 His nondeductible IRA (immediate backdoor Roth conversion)
$5,000 Her nondeductible IRA (immediate backdoor Roth conversion)
(Wife ineligible for 403(b) or Spousal IRA as fellow earning stipend, not W2 income).
$12,000 taxable committed to ESPP (15% discount)
$12,000 taxable (approximate)

All options in 401(k):
Vanguard Target Retirement 2030 Trust I (0.08%)
Vanguard Admiral Treasury MM Fund (VUSXX) (0.12%) not rated
Vanguard Prime Money Market Portfolio (VMRXX) (0.12%) not rated
Vanguard Inflation-Protected Securities; Institutional (0.07%) 5*
Vanguard Institutional Index S&P 500 (VIIIX) (0.02%) 5*
Longleaf Partners Fund (LLPFX) (0.91%) 1*
Vanguard Value Index Institutional (0.08%) 5*
Vanguard MidCap Index Fund (VMCIX) (0.06%) 4* not rated?
Vanguard Small Cap Index (VSCIX) (0.12%) 4*
Vanguard REIT Index Fund (VGSNX) (0.08%) 5*
Vanguard Total Bond Market Index Fund (VBTIX) (0.05%)
Vanguard Total International Index (VGTSX) (0.10%) 4* not rated?
Vanguard Emerging Markets Fund (VEMIX) (0.10%) 3*not rated?
Vanguard Growth Index (0.08%) 5*
Marsico Growth (MGRIX) (1.33%) 3*
Pimco Stable Value Fund (PMDRX) (0.65%) not rated
Pimco Total Return Fund (PTTRX) (0.46%) 5*
Fidelity OTC Portfolio (FOCPX) (0.91%) 5*
Fidelity Contrafund (FCNTX) (0.81%) 5*
Royce Opportunity Fund (RYPNX) (1.04%) 4*
American New Perspective Fund (ANWPX) (0.46%) 5*

QUESTIONS:
1. I think we can afford to be a bit more risk-averse now, because of the amount we have accumulated and our ages, and am thinking of moving us closer to a 60/40 stock/bond split than where we are now (67/33). Thoughts?
2. Would it make sense for us to open a Roth 401(k) (an option through husband’s employer, in addition to the regular 401(k))? We would use this for the money that would otherwise go to the taxable Vanguard accounts.
3. What is the best way to rebalance – in terms of the accounts that we actually touch and the source of the monies? Aside from having too much in employer stock, the biggest discrepancies right now are the international allocation (40% under target) and the non-TIPS bond allocation (40% under target). We are ready to put our $10k into IRAs in the next month – would it make sense to put these into international or regular bond funds instead of the TIPS fund as we have been allocating? Or should we move money around in the 401k instead? Or some other solution?
4. We contribute about 24k to kids’ 529 plans annually. How does this fit into our planning? So far I am considering it a separate bucket and the totals that we have so far in those accounts are not included in our asset allocation planning.
5. Any comments on our overall strategy?

[bdpb]

Mortgage on principal home (380k @ 4.75 fixed)

Federal tax rate: 33%
State tax rate: 5.25% plus County Tax 3.2%

Her Rollover IRA with Vanguard (10.2% of total portfolio) – rolled over 401k from former company

Taxable (40.1% of total portfolio)
11.6% - Vanguard Total Stock Market Admiral (VTSAX) (0.06%)
10.3% - Vanguard FTSE Ex-US Index Admiral (VTIAX) (0.18%)
13.6% - Employer Stock – international, diversified professional services organization (ESPP at 15% discount; purchased 10% of income since 2001 and have sold sporadically. Trying to convince husband to cut this down to 8%...but hard to convince when the stock has outperformed all other investments annually.)

New annual contributions
$24,200 His 401(k) (including matching contributions)
$5,000 Her nondeductible IRA (immediate backdoor Roth conversion)
$12,000 taxable (approximate)

QUESTIONS:
2. Would it make sense for us to open a Roth 401(k) (an option through husband’s employer, in addition to the regular 401(k))? We would use this for the money that would otherwise go to the taxable Vanguard accounts.

At these tax rates, I would not contribute to Roth 401k. I would continue a deductible contribution. Make sure he is maxing his contribution to 401k.

Are you sure you are doing the backdoor Roth conversion of her IRA correctly? It should be prorated with her existing IRA. I would stop her nondeductible IRA contribution and conversion and use the money elsewhere.

I would not hold so much in company stock. I've worked for a company with a high flying stock price and saw it collapse. Many folks lost virtually all of the their assets that way.

I would invest my future taxable savings in my mortgage. You can't find a better bond like return anywhere else. I would also use the 5k that was scheduled for her non-deductible IRA for this, too. I would also consider selling other taxable assets for this depending on the tax consequences. Taxable investing is scheduled to go up next year even if the existing laws don't change.

Refinance your mortgage. You should be able to get a 30 year loan a bit over 3%.

[zebrafish]

Ditto the company stock concern. This is potentially a huge risk.

My father lost 50% of his retirement (about 2.5 million dollars) when his company went bankrupt.

[sksavers2]

Thanks for the feedback so far! (I KNOW about the company stock...need to get DH on board...grrrr.)

I think we are doing the IRA backdoor correctly, but it is also debatable. My rollover is a completely different account and has never been mingled with my regular IRA (traditional or Roth), so I think I have an argument for not mingling it.

We refinanced the mortgage last year, and there is a good chance we will be selling the house and moving again next year or the year after, so refinancing now or investing in paying it down is not a good idea or a priority for us now. It will probably end up being a financial mistake to have bought this house since we are probably going to be moving for my job, but we knew that risk going in. In light of this information, what would you advise we do with our extra planned savings?

[Grt2bOutdoors]

Many here typically view the 529 plans as you are - a separate bucket based on the time horizon of each child's need.

I would keep funding the spousal IRA then convert using backdoor option.

If you can't come up with a good place to invest extra taxable, how about I-bonds - though you won't be able to access it for the first year due to Treasury lock-up provisions.

[Duckie]

I think we are doing the IRA backdoor correctly, but it is also debatable. My rollover is a completely different account and has never been mingled with my regular IRA (traditional or Roth), so I think I have an argument for not mingling it.

The IRS considers all non-Roth IRAs to be one big fat IRA. SEP-IRAs, SIMPLE-IRAs, Traditional IRAs (with or without non-deductible contributions), and Rollover IRAs (which are considered the same as Traditional IRAs for this purpose) are all included in the mix. Mingling isn't the issue.

For example, if you have a Rollover IRA worth $95,000 (all pre-tax) and make a $5,000 non-deductible contribution to a Traditional IRA and then convert it, you will have to pay taxes on 95% of the conversion. The taxes are pro-rated. See 
Backdoor Roth IRA
 and IRS Form 8606.

[sksavers2]

duckie wrote:

The IRS considers all non-Roth IRAs to be one big fat IRA. SEP-IRAs, SIMPLE-IRAs, Traditional IRAs (with or without non-deductible contributions), and Rollover IRAs (which are considered the same as Traditional IRAs for this purpose) are all included in the mix. Mingling isn't the issue.

For example, if you have a Rollover IRA worth $95,000 (all pre-tax) and make a $5,000 non-deductible contribution to a Traditional IRA and then convert it, you will have to pay taxes on 95% of the conversion. The taxes are pro-rated. See 
Backdoor Roth IRA
 and IRS Form 8606.

This is helpful. Here's the situation, would be great if you could help clarify:
At the time we made the initial rollover, there were no gains (I rolled over with losses). The same year of the rollover was the first time I did backdoor Roth from a $5k contribution to a traditional nondeductible IRA. So that year I would have owed no taxes on the conversion because there was no gain. The second, third, fourth, etc... years I did a backdoor Roth, I probably did have gains on the original Rollover IRA (which is no longer getting contributions except for reinvested dividends). Would I owe taxes on the proportion of the 5k new contribution to be converted relative to the Rollover amount (the proportion of the Rollover IRA is getting smaller relative to the Roth IRA as each year I am adding to the Roth IRA)?

[Bob's not my name]

My job now provides about 30% of our family income
Federal tax rate: 33%
State tax rate: 5.25% plus County Tax 3.2%

New annual contributions
$24,200 His 401(k) (including matching contributions)
(Wife ineligible for 403(b) or Spousal IRA as fellow earning stipend, not W2 income).
$12,000 taxable committed to ESPP (15% discount)

A few things here don't make sense to me, but I'm reverse engineering your numbers to infer your income, so I could be wrong.

• To be in the 33% bracket you would have to have gross income over about $290,000. That would make your income (30% of family income) at least $90,000 and his at least $200,000. But his 401k and ESPP numbers suggest to me his income is $120,000 (10% to ESPP = $12,000, and 6% employer 401k match + $17,000 = $24,200), which would make your income about $60,000, your combined gross income about $180,000, your AGI about $150,000 (well under the direct Roth IRA and spousal TIRA phaseout), and your taxable income about $110,000, which is way down in the 25% bracket. So I must be inferring incorrectly, right?
• That looks like MD state tax, but the MD state tax was increased retroactively this year, so if you're really in the 33% federal bracket your state rate would be 5.75% + 3.2% = 8.95%
• Eligibility for a spousal IRA does not depend on W2 income, since the other spouse's earned income makes you eligible. Rather, there is a MAGI limit on eligibility for deductible TIRA contributions, which is the same as the Roth MAGI limit. So ... are you really ineligible for Roth and spousal TIRA contributions?

Also, have your spouse read this on ESPP: http://thefinancebuff.com/employee-stoc ... pp-is.html

[Duckie]

At the time we made the initial rollover, there were no gains (I rolled over with losses). The same year of the rollover was the first time I did backdoor Roth from a $5k contribution to a traditional nondeductible IRA. So that year I would have owed no taxes on the conversion because there was no gain.

It doesn't matter whether there was a gain or a loss. What matters is the value of all your non-Roth IRAs at the end of the year. That number goes on Form 8606 line 6.

The second, third, fourth, etc... years I did a backdoor Roth, I probably did have gains on the original Rollover IRA (which is no longer getting contributions except for reinvested dividends).

Okay, this puzzles me. The Backdoor Roth IRA option only became viable in 2010 when the $100,000 income limit on Roth IRA conversions was removed. Its purpose is to allow people with too much income for "direct" Roth IRA contributions to contribute "indirectly" using the "back door" method. This couldn't happen before 2010 because of the conversion income limit, so 2012 is only the third year this is possible. Are you sure we're talking (writing) about the same thing?

Would I owe taxes on the proportion of the 5k new contribution to be converted relative to the Rollover amount (the proportion of the Rollover IRA is getting smaller relative to the Roth IRA as each year I am adding to the Roth IRA)?

Using round numbers, if you make a non-deductible contribution of $5,000 and convert it (assuming it's the only basis), and at the end of the year have $105,000 in non-Roth IRAs, then 95.5% (105/110) is taxable. If at the end of the year you have $86,000 in non-Roths then 94.5% (86/91) is taxable, and so on. It's all figured on Form 8606.

[sksavers2]

A few things here don't make sense to me, but I'm reverse engineering your numbers to infer your income, so I could be wrong.[list][*]To be in the 33% bracket you would have to have gross income over about $290,000. That would make your income (30% of family income) at least $90,000 and his at least $200,000. But his 401k and ESPP numbers suggest to me his income is $120,000 (10% to ESPP = $12,000, and 6% employer 401k match + $17,000 = $24,200), which would make your income about $60,000, your combined gross income about $180,000, your AGI about $150,000 (well under the direct Roth IRA and spousal TIRA phaseout), and your taxable income about $110,000, which is way down in the 25% bracket. So I must be inferring incorrectly, right?[*]That looks like MD state tax, but the MD state tax was increased retroactively this year, so if you're really in the 33% federal bracket your state rate would be 5.75% + 3.2% = 8.95%[*]

You are inferring exactly right (actually spot-on! I make 65k so our total is 185k plus his variable pay). I was looking at the wrong tax rate. I think we are actually in the 28% bracket in gross dollars and didn't consider that the 401k contributions drop us down. This will be the first year that we are actually under the Roth phaseout because our income was actually variable but close to or above 200k for a couple of years.

I don't know about the MD tax increase but yes, that's our state.

Eligibility for a spousal IRA does not depend on W2 income, since the other spouse's earned income makes you eligible. Rather, there is a MAGI limit on eligibility for deductible TIRA contributions, which is the same as the Roth MAGI limit. So ... are you really ineligible for Roth and spousal TIRA contributions?

MAGI is confusing to me. I don't think our MAGI is much different than our AGI, which for the last few years has put us above the Roth and spousal TIRA contribution limits.

Also, have your spouse read this on ESPP: http://thefinancebuff.com/employee-stoc ... pp-is.html

Awesome link, thanks!

[sksavers2]

At the time we made the initial rollover, there were no gains (I rolled over with losses). The same year of the rollover was the first time I did backdoor Roth from a $5k contribution to a traditional nondeductible IRA. So that year I would have owed no taxes on the conversion because there was no gain.

It doesn't matter whether there was a gain or a loss. What matters is the value of all your non-Roth IRAs at the end of the year. That number goes on Form 8606 line 6.

Lightbulb just went on! I owe taxes because all the Rollover IRA money was taken out of my paychecks pre-tax and Roth money should be post-tax.

The second, third, fourth, etc... years I did a backdoor Roth, I probably did have gains on the original Rollover IRA (which is no longer getting contributions except for reinvested dividends).

Okay, this puzzles me. The Backdoor Roth IRA option only became viable in 2010 when the $100,000 income limit on Roth IRA conversions was removed. Its purpose is to allow people with too much income for "direct" Roth IRA contributions to contribute "indirectly" using the "back door" method. This couldn't happen before 2010 because of the conversion income limit, so 2012 is only the third year this is possible. Are you sure we're talking (writing) about the same thing?

Sorry to be confusing, yes, we're writing about the same thing, just got carried away and careless. 2012 will be the 3rd year assuming I'm doing this legitimately and don't have to re-recharacterize or reverse what I did for 2010 and 2011.

Would I owe taxes on the proportion of the 5k new contribution to be converted relative to the Rollover amount (the proportion of the Rollover IRA is getting smaller relative to the Roth IRA as each year I am adding to the Roth IRA)?

Using round numbers, if you make a non-deductible contribution of $5,000 and convert it (assuming it's the only basis), and at the end of the year have $105,000 in non-Roth IRAs, then 95.5% (105/110) is taxable. If at the end of the year you have $86,000 in non-Roths then 94.5% (86/91) is taxable, and so on. It's all figured on Form 8606.

Wait. Really?? This seems like getting taxed on the same money over and over again.

[bdpb]

... there is a good chance we will be selling the house and moving again next year or the year after, so ... investing in paying it down is not a good idea ...

This actually argues more in favor of putting all of your near term future taxable savings towards the mortgage. Any money that is used to pay the mortgage effectively earns a taxable 4.75% (since you will no longer pay interest on it). When you sell in the near future, you can take back as much of this savings as you want.

This is essentially like earning 4.75% on a one or two year CD. This is an excellent return. One or two year CDs are earning around 1% or less.

[Default User BR]

Using round numbers, if you make a non-deductible contribution of $5,000 and convert it (assuming it's the only basis), and at the end of the year have $105,000 in non-Roth IRAs, then 95.5% (105/110) is taxable. If at the end of the year you have $86,000 in non-Roths then 94.5% (86/91) is taxable, and so on. It's all figured on Form 8606.

Wait. Really?? This seems like getting taxed on the same money over and over again.

No. The way pro-rata works is that you can't convert just the non-taxable portion. If you do a conversion of X dollars, then a portion of it is taxable. That is figured by multiplying the conversion amount by T/(T+N), where T = taxable amount and N = non-taxable amount. So if T = 0, then none is taxable. After you figure that, then you are withdrawing from both the taxable and non-taxable portions of the IRA in proportion to the taxable percentage.

As suggested, get a copy of 8606 and work through an example.


Brian

[Bob's not my name]

A few things here don't make sense to me, but I'm reverse engineering your numbers to infer your income, so I could be wrong.[list][*]To be in the 33% bracket you would have to have gross income over about $290,000. That would make your income (30% of family income) at least $90,000 and his at least $200,000. But his 401k and ESPP numbers suggest to me his income is $120,000 (10% to ESPP = $12,000, and 6% employer 401k match + $17,000 = $24,200), which would make your income about $60,000, your combined gross income about $180,000, your AGI about $150,000 (well under the direct Roth IRA and spousal TIRA phaseout), and your taxable income about $110,000, which is way down in the 25% bracket. So I must be inferring incorrectly, right?[*]That looks like MD state tax, but the MD state tax was increased retroactively this year, so if you're really in the 33% federal bracket your state rate would be 5.75% + 3.2% = 8.95%[*]

You are inferring exactly right (actually spot-on! I make 65k so our total is 185k plus his variable pay). I was looking at the wrong tax rate. I think we are actually in the 28% bracket in gross dollars and didn't consider that the 401k contributions drop us down.

Your bracket is based on your taxable income, not your gross income, and surely you are in the 25% bracket for 2012 (under current law this will be 28% in 2013).

$185,000 gross income (not including any bonus and any net rental income)
- $17,000 401k contribution ($17,500 in 2013)
- $4,000 pre-tax health, dental, and disability insurance premiums withheld from your pay (guess)
- $3,000 FSA contributions (guess)
------------
$161,000 MAGI --> way under the Roth IRA phaseout (which starts at $173,000 for 2012 and $178,000 for 2013)
- $15,200 personal exemptions
- $25,000 itemized deductions (guess based on your high mortgage and high state taxes and guessing at high property tax)
------------
$121,000 taxable income --> way under this year's 28% bracket

Your marginal rate is actually 25% + 7.95% MD deductible against federal so effectively 6% = 31%

Under current law your 2013 marginal rate will be 28% + 5.7% effective state tax = 33.7%

By the way, I still don't understand what's going on with your IRAs, but be aware that MD and PA taxation of IRAs is different. PA treats everything like a Roth (viz., no deduction for TIRA contribution, no tax on conversion after 59.5, I think), whereas MD follows federal practice. I just mention this because it might be a point of confusion.

[interplanetjanet]

$161,000 MAGI --> way under the Roth IRA phaseout (which starts at $173,000 for 2012 and $178,000 for 2013)
- $15,200 personal exemptions
- $25,000 itemized deductions (guess based on your high mortgage and high state taxes and guessing at high property tax)
------------
$121,000 taxable income --> way under this year's 28% bracket

Your marginal rate is actually 25% + 5% due to child tax credit phaseout + 7.95% MD deductible against federal so effectively 6% = 36%

It's worth noting that they could bump up against AMT if deductions and exemptions are high, especially if there is more income from a bonus. This would raise their marginal rate as they would be in the AMT phaseout.

[Bob's not my name]

Agreed. In the lower end of the AMT the effective marginal rate is 32.5% and state tax is not deductible, so your marginal rate could be 32.5% + 7.95% = 40.5%. Throw in payroll taxes and you are losing over 45% of the lower earning spouse's pay to taxes.

Also, I screwed up on the child tax credit phaseout -- for two kids it would be over $110,000 - $150,000 AGI, so they're above it. I'll amend my post.

[sksavers2]

Agreed. In the lower end of the AMT the effective marginal rate is 32.5% and state tax is not deductible, so your marginal rate could be 32.5% + 7.95% = 40.5%. Throw in payroll taxes and you are losing over 45% of the lower earning spouse's pay to taxes.

Yes. Last year and I think 2010 we paid AMT. I am embarrassed that I can't calculate our household income correctly but to be fair it has been variable and the last few years big chunks of DH's compensation has included bonuses that he can't control. This will be the last year we have that bonus income, and it was smaller than previous years. In 2011, we had AGI of 234k and taxable income of 187k and paid an effective tax rate of 15.54% (this is off TurboTax summary). 2011 included big bonus and a lot of long-term stock gains from selling large amounts of the ESPP. For 2012, we will have substantially lower income, smaller bonus, and some long-term stock gains from ESPP, so much lower total (and hopefully taxable) income. In 2011, we had itemized deductions of 32k (state/local income tax, property tax, mortgage interest, and charity). I should note that we bought the house mid-last year so our mortgage interest deduction will be higher in 2012 although not double since we refinanced in Dec 2011.

We do not qualify for the child care tax credit (the child care savings account) because I don't have earned income (stipend doesn't count) and therefore I should be staying home to take care of them (rant). We no longer put money into flexible spending account because my insurance is incredible and we pay probably <$100/year out of pocket. Health insurance is 100% paid by my employer so we don't have any pre-tax deductions for that. We do have pre-tax dental insurance but it's <600/year.

[sksavers2]

... there is a good chance we will be selling the house and moving again next year or the year after, so ... investing in paying it down is not a good idea ...

This actually argues more in favor of putting all of your near term future taxable savings towards the mortgage. Any money that is used to pay the mortgage effectively earns a taxable 4.75% (since you will no longer pay interest on it). When you sell in the near future, you can take back as much of this savings as you want.

This is essentially like earning 4.75% on a one or two year CD. This is an excellent return. One or two year CDs are earning around 1% or less.

If we think we will lose money on the sale, does this logic still work? We hope we can sell the house for what we paid, but most likely it will sell for a little less, and the transaction costs will be ~10%, so we are looking at losing about 15% of the sales price...which is almost all of the 20% down payment we made.

[sksavers2]

Using round numbers, if you make a non-deductible contribution of $5,000 and convert it (assuming it's the only basis), and at the end of the year have $105,000 in non-Roth IRAs, then 95.5% (105/110) is taxable. If at the end of the year you have $86,000 in non-Roths then 94.5% (86/91) is taxable, and so on. It's all figured on Form 8606.

Wait. Really?? This seems like getting taxed on the same money over and over again.

No. The way pro-rata works is that you can't convert just the non-taxable portion. If you do a conversion of X dollars, then a portion of it is taxable. That is figured by multiplying the conversion amount by T/(T+N), where T = taxable amount and N = non-taxable amount. So if T = 0, then none is taxable. After you figure that, then you are withdrawing from both the taxable and non-taxable portions of the IRA in proportion to the taxable percentage.

As suggested, get a copy of 8606 and work through an example.

Brian

I filled out 8606 for the last 2 years for the conversion but now I'm worried I did it wrong. In Part 1, I put $0 for Line 1, Total Basis in Traditional IRAs. I think what I'm understanding from this thread is that I should be including as the basis the amount in the Rollover IRA. Yes?

[Bob's not my name]

We do not qualify for the child care tax credit (the child care savings account)

I was referring to the child tax credit. You are referring to two other things: the dependent care tax credit and the dependent care FSA. You are probably ineligible for the first (it phases out for two kids over AGI $110,000 - $150,000). I don't know about eligibility for the other two.

[bdpb]

... there is a good chance we will be selling the house and moving again next year or the year after, so ... investing in paying it down is not a good idea ...

This actually argues more in favor of putting all of your near term future taxable savings towards the mortgage. Any money that is used to pay the mortgage effectively earns a taxable 4.75% (since you will no longer pay interest on it). When you sell in the near future, you can take back as much of this savings as you want.

This is essentially like earning 4.75% on a one or two year CD. This is an excellent return. One or two year CDs are earning around 1% or less.

If we think we will lose money on the sale, does this logic still work? We hope we can sell the house for what we paid, but most likely it will sell for a little less, and the transaction costs will be ~10%, so we are looking at losing about 15% of the sales price...which is almost all of the 20% down payment we made.

Yes. If the house sells for less, you're going to have to come up with the difference anyway.

[Duckie]

I filled out 8606 for the last 2 years for the conversion but now I'm worried I did it wrong. In Part 1, I put $0 for Line 1, Total Basis in Traditional IRAs. I think what I'm understanding from this thread is that I should be including as the basis the amount in the Rollover IRA. Yes?

The following are a couple of examples using Form 8606 and its instructions.

Example 1:
1. You have no non-Roth IRAs at the beginning of the year (SEP-IRAs, SIMPLE-IRAs, Traditional IRAs, or Rollover IRAs).
2. In January you make a $5,000.00 non-deductible contribution to a new Traditional IRA.
3. In May you convert the entire amount of the Traditional IRA (which is now $5,025.00) to a Roth IRA.
4. At the end of the year your Traditional IRA is empty.
5. You fill out Form 8606 to file with your taxes.

Part I, line 1 is 5,000.00 (the amount of your non-deductible contribution)
Line 2 is 0 (because you have no previous basis in the Traditional IRA)
Line 3 is 5,000.00
Line 4 is 0 or blank
Line 5 is 5,000.00
Line 6 is 0 or blank (the total amount in all your non-Roth IRAs)
Line 7 is 0 or blank
Line 8 is 5,025.00
Line 9 is 5,025.00
Line 10 is 0.995
Line 11 is 4,999.88
Line 12 is 0
Line 13 is 4,999.88
Line 14 is 25.12
Line 15 is 0
Part II, line 16 is 5,025.00
Line 17 is 4,999.88
Line 18 is 25.12 (you will pay taxes on this amount)

Example 2:
1. You have a Rollover IRA of $105,000.00 (all pre-tax) at the beginning of the year. This is the only non-Roth IRA you have. (For Form 8606 purposes a Rollover IRA is the same as a Traditional IRA.)
2. In January you make a $5,000.00 non-deductible contribution to a new Traditional IRA.
3. In May you convert the entire amount of the Traditional IRA (which is now $5,025.00) to a Roth IRA.
4. At the end of the year your Traditional IRA is empty and your Rollover IRA is $110,000.00.
5. You fill out Form 8606 to file with your taxes.

Part I, line 1 is 5,000.00 (the amount of your non-deductible contribution)
Line 2 is 0 (because you have no previous basis in the Traditional IRA or the Rollover IRA)
Line 3 is 5,000.00
Line 4 is 0 or blank
Line 5 is 5,000.00
Line 6 is 110,000.00 (the total amount in all your non-Roth IRAs)
Line 7 is 0 or blank
Line 8 is 5,025.00
Line 9 is 115,025.00
Line 10 is 0.043
Line 11 is 216.08
Line 12 is 0
Line 13 is 216.08
Line 14 is 4,783.92 (next year this will be your basis on line 2)
Line 15 is 0
Part II, line16 is 5,025.00
Line 17 is 216.08
Line 18 is 4,808.92 (you will pay taxes on this amount)

You may need to amend your taxes for 2010, 2011.

[2stepsbehind]

I, for one, just want to thank you for providing an update. It isn't often that people come back on the board to discuss how they've implemented some of the advice they've received. Kudos to you and best wishes with this next phase.

[sksavers2]

I, for one, just want to thank you for providing an update. It isn't often that people come back on the board to discuss how they've implemented some of the advice they've received. Kudos to you and best wishes with this next phase.

Thanks, 2stepsbehind. We've gotten such great advice here (most of which has been incredibly valuable, and all of which has made us think), that I think it's only fair to report back. Plus, obviously, we still need help!

[sksavers2]

Example 2:
1. You have a Rollover IRA of $105,000.00 (all pre-tax) at the beginning of the year. This is the only non-Roth IRA you have. (For Form 8606 purposes a Rollover IRA is the same as a Traditional IRA.)
2. In January you make a $5,000.00 non-deductible contribution to a new Traditional IRA.
3. In May you convert the entire amount of the Traditional IRA (which is now $5,025.00) to a Roth IRA.
4. At the end of the year your Traditional IRA is empty and your Rollover IRA is $110,000.00.
5. You fill out Form 8606 to file with your taxes.

Part I, line 1 is 5,000.00 (the amount of your non-deductible contribution)
Line 2 is 0 (because you have no previous basis in the Traditional IRA or the Rollover IRA)
Line 3 is 5,000.00
Line 4 is 0 or blank
Line 5 is 5,000.00
Line 6 is 110,000.00 (the total amount in all your non-Roth IRAs)
Line 7 is 0 or blank
Line 8 is 5,025.00
Line 9 is 115,025.00
Line 10 is 0.043
Line 11 is 216.08
Line 12 is 0
Line 13 is 216.08
Line 14 is 4,783.92 (next year this will be your basis on line 2)
Line 15 is 0
Part II, line16 is 5,025.00
Line 17 is 216.08
Line 18 is 4,808.92 (you will pay taxes on this amount)

You may need to amend your taxes for 2010, 2011.

[/quote]

Oh boy. I think Example 2 is probably more in line with what I should have done and will need to amend 2010 and 2011 taxes. I thought doing my taxes was the thing I dreaded the most but redoing them just took that honor. Thanks so much for the really clear examples, Duckie. I wonder if it's time to pay a professional.

[sksavers2]

... there is a good chance we will be selling the house and moving again next year or the year after, so ... investing in paying it down is not a good idea ...

This actually argues more in favor of putting all of your near term future taxable savings towards the mortgage. Any money that is used to pay the mortgage effectively earns a taxable 4.75% (since you will no longer pay interest on it). When you sell in the near future, you can take back as much of this savings as you want.

This is essentially like earning 4.75% on a one or two year CD. This is an excellent return. One or two year CDs are earning around 1% or less.

If we think we will lose money on the sale, does this logic still work? We hope we can sell the house for what we paid, but most likely it will sell for a little less, and the transaction costs will be ~10%, so we are looking at losing about 15% of the sales price...which is almost all of the 20% down payment we made.

Yes. If the house sells for less, you're going to have to come up with the difference anyway.

This is great food for thought. Thanks, bdpb.