Questions About 401k and AGI and Traditional vs Roth IRAs

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ShimmyShuffle
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Questions About 401k and AGI and Traditional vs Roth IRAs

Post by ShimmyShuffle »

Hi Everyone,

Rundown of my circumstances:

I will make approximately 70k this year, and I'm single. There's a strong possibility my income could increase to 80k give or take a few k within the next 5 years. I max out my 401k and started a Roth IRA last year and contributed the max for 2013 and 2014.

Lately I have been wondering if I should have gone the traditional IRA route but was unclear about whether or not I would be eligible for the tax deduction (numbers confuse me lol). My questions are as follows:

1) If I make 70k but max the 401k and get the standard tax deduction does that bring my AGI below the 60k limit which allows me to deduct the Traditional IRA on my taxes? I know the math tells me it does, but I'm unsure if 401k contributions are factored in when calculating AGI.

2) If that's the case, should I begin a Traditional IRA now or keep going with the Roth? I don't think I'd be able to fund both a Roth and Traditional, so the Roth may end up just sitting there and going forward I would keep maxing the 401k and Traditional.

3) Is it possible to "recharacterize" the Roth as Traditional, and would there be any benefits/drawbacks in doing so like allowing me to deduct this year's contribution of 5500? I did kind of like the idea of being able to withdraw the contributions made to the Roth without penalties in the event something necessitated it, but I know that in the event I wanted to retire early there are ways to access the IRA money prior to standard retirement age.

If there's any additional info needed in order to assist please let me know. I appreciate any insights you all may have.
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dodecahedron
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by dodecahedron »

If I make 70k but max the 401k and get the standard tax deduction does that bring my AGI below the 60k limit which allows me to deduct the Traditional IRA on my taxes? I know the math tells me it does, but I'm unsure if 401k contributions are factored in when calculating AGI.
If you contribute to a traditional 401K (not a Roth 401K), then yes, your contributions to the 401K will reduce your AGI because they will reduce box 1 on your W-2, which is what goes on line 7 of your 1040 and ultimately into your AGI.

However, I don't know why you mention the "standard deduction" at all. Your standard deduction does NOT reduce your AGI. It reduces your taxable income but not your AGI.

But you should also bear in mind that what is relevant for deductible traditional IRA eligibility is not exactly your AGI, it is your MAGI (Modified AGI) as defined in this publication. http://www.irs.gov/publications/p590/ch02.html

For me, it is sufficiently complicated and close so I will wait until I have all my numbers (including uncertain things like fourth quarter dividends) before deciding whether to go with deductible traditional IRA or Roth this year.

As for your question about recharacterization, yes it is possible, but it's a pain in the posterior. (My husband and I did something like this once, when we had accidentally overcontributed to an SEP-IRA, but it was a paperwork hassle and I have resolved to avoid such things in the future. Life is too short to spend time dealing with stuff like that.)
http://www.investopedia.com/articles/re ... 092403.asp
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dodecahedron
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by dodecahedron »

ShimmyShuffle wrote:?I don't think I'd be able to fund both a Roth and Traditional, so the Roth may end up just sitting there and going forward I would keep maxing the 401k and Traditional.
Your statement quoted above makes me wonder if you understand that your total annual IRA contributions are limited to $5,500. You can split your contributions anyway you like between your traditional and Roth IRAs (assuming you choose to contribute to both in a given year), but the total contribution is limited to $5,500. (Unless you are married and/or over 50, in which case you can you can contribute to a spousal IRA for a spouse without income and/or make a catchup additional contribution of $1,000.)
Topic Author
ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Yes it's Traditional 401k.

Thank you for the correction on the standard deduction. I was not aware.
But you should also bear in mind that what is relevant for deductible traditional IRA eligibility is not exactly your AGI, it is your MAGI (Modified AGI) as defined in this publication. http://www.irs.gov/publications/p590/ch02.html
I'll need to do more digging to understand the specifics on MAGI I'm sure. This seems like such a silly question, but if for example my MAGI was right over the limit for deducting a Traditional IRA contribution (just over 60k in my case) and then I contributed the 5,500 to the IRA, that would bring me under the limit right?
As for your question about recharacterization, yes it is possible, but it's a pain in the posterior. (My husband and I did something like this once, when we had accidentally overcontributed to an SEP-IRA, but it was a paperwork hassle and I have resolved to avoid such things in the future. Life is too short to spend time dealing with stuff like that.)
Yes, if it ends up looking like too much of a hassle I will avoid. I will call Vanguard and speak with them about it to see what it entails.
Your statement quoted above makes me wonder if you understand that your total annual IRA contributions are limited to $5,500.
You'd be right to wonder. If you're saying I can't contribute 5,500 each to Roth and Traditional IRAs, only 5,500 to one or split between the two then this would be news to me. Seems unfortunate that a limitation like that is in place. If I'm understanding you correctly then thank you for the clarification.
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dodecahedron
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by dodecahedron »

ShimmyShuffle wrote:Yes it's Traditional 401k.

Thank you for the correction on the standard deduction. I was not aware.
dodecahedron wrote:But you should also bear in mind that what is relevant for deductible traditional IRA eligibility is not exactly your AGI, it is your MAGI (Modified AGI) as defined in this publication. http://www.irs.gov/publications/p590/ch02.html
I'll need to do more digging to understand the specifics on MAGI I'm sure. This seems like such a silly question, but if for example my MAGI was right over the limit for deducting a Traditional IRA contribution (just over 60k in my case) and then I contributed the 5,500 to the IRA, that would bring me under the limit right?
Wrong. If you look at the details of the MAGI calculation, you will find that that you would need to add back your traditional IRA contribution to your AGI as part of the calculation of your MAGI. So contributing to a traditional IRA won't help your eligibility.
ShimmyShuffle wrote:
dodecahedron wrote:Your statement quoted above makes me wonder if you understand that your total annual IRA contributions are limited to $5,500.
You'd be right to wonder. If you're saying I can't contribute 5,500 each to Roth and Traditional IRAs, only 5,500 to one or split between the two then this would be news to me. Seems unfortunate that a limitation like that is in place. If I'm understanding you correctly then thank you for the clarification.
You are indeed understanding me correctly. You may not contribute $5,500 each to your Roth and traditional IRAs in the same year.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Wrong. If you look at the details of the MAGI calculation, you will find that that you would need to add back your traditional IRA contribution to your AGI as part of the calculation of your MAGI. So contributing to a traditional IRA won't help your eligibility.
Those crafty mccraftersons. lol. That is unfortunate.
Bob's not my name
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

Look at your W2 and page one of your 1040 to see what factors reduce your AGI. One big factor is pre-tax health, dental, and disability insurance premiums withheld from your pay. For many people this is a few thousand. Then there are health FSA contributions. And the 401k contribution limit will be $18,000 next year. So your AGI/MAGI ought to be at least $20,000 below your gross income.

If you're maxing your 401k and a Roth IRA it's probably fine to go with that mix. If you have a state tax too you are paying a lot of tax on your Roth IRA contribution (maybe $2,500), which is painful, but bear in mind that if you go with a traditional IRA you can't fit the whole $8,000 of gross pay into it, only $5,500 and then you still have $2,500 of gross pay that will be taxed willy nilly.
Carl53
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Carl53 »

ShimmyShuffle wrote:
Wrong. If you look at the details of the MAGI calculation, you will find that that you would need to add back your traditional IRA contribution to your AGI as part of the calculation of your MAGI. So contributing to a traditional IRA won't help your eligibility.
Those crafty mccraftersons. lol. That is unfortunate.
But boosting contributions to the 401k (pretax) or FSA will reduce your MAGI and perhaps allow a deductible TIRA.
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dodecahedron
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by dodecahedron »

Carl53 wrote:
ShimmyShuffle wrote:
Wrong. If you look at the details of the MAGI calculation, you will find that that you would need to add back your traditional IRA contribution to your AGI as part of the calculation of your MAGI. So contributing to a traditional IRA won't help your eligibility.
Those crafty mccraftersons. lol. That is unfortunate.
But boosting contributions to the 401k (pretax) or FSA will reduce your MAGI and perhaps allow a deductible TIRA.
Alternatively, if you have a high-deductible health plan (HDHP), you can contribute to an HSA instead of an FSA, which may have some advantages. Contributions to an HSA will also reduce your MAGI. (Be careful not to contribute to both an HSA and an FSA, however.)
Bob's not my name
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

I don't see any issues with deductible TIRA eligibility. $70,000 of gross income probably puts your MAGI below $50,000, so you have lots of headroom.

In 2015 you're fully eligible if your MAGI is below $61,000. That probably equates to about $82,000 gross income. The 401k contribution limit and the deductible TIRA eligibility threshold are both inflation-adjusted, so the threshold recedes from you as your approach it.
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retiredjg
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by retiredjg »

I think you should consider using Roth IRA, or at least some Roth IRA, even if you are eligible to deduct your tIRA contribution. Having both untaxed money (in your 401k) and already taxed money (in your Roth IRA) gives you some tax-diversification. Having both gives you some additional flexibility in retirement.

Also, the contributions to Roth IRA (but not the earnings) are available to you anytime without penalty. This gives you a back up to your emergency fund.
Topic Author
ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Carl53 wrote:
ShimmyShuffle wrote:
Wrong. If you look at the details of the MAGI calculation, you will find that that you would need to add back your traditional IRA contribution to your AGI as part of the calculation of your MAGI. So contributing to a traditional IRA won't help your eligibility.
Those crafty mccraftersons. lol. That is unfortunate.
But boosting contributions to the 401k (pretax) or FSA will reduce your MAGI and perhaps allow a deductible TIRA.
I'm already maxing the 401k and the FSA is something I avoid because I don't really go to the doctor often. I'd probably end up never being able to accurately calculate what to put in and don't want to lose any of it.
Alternatively, if you have a high-deductible health plan (HDHP), you can contribute to an HSA instead of an FSA, which may have some advantages. Contributions to an HSA will also reduce your MAGI. (Be careful not to contribute to both an HSA and an FSA, however.)
Unfortunately, I don't have access to this. I've read that HSAs can really be used to a person's advantage, so I would have loved to have the option of exploring it.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Bob's not my name wrote:I don't see any issues with deductible TIRA eligibility. $70,000 of gross income probably puts your MAGI below $50,000, so you have lots of headroom.

In 2015 you're fully eligible if your MAGI is below $61,000. That probably equates to about $82,000 gross income. The 401k contribution limit and the deductible TIRA eligibility threshold are both inflation-adjusted, so the threshold recedes from you as your approach it.
Interesting, I figured I'd be above 50k because the only thing I really think would be deducted would be the 401k. I'm not really aware of what else I could use to reduce my MAGI. I checked some of the available info on the net, and it doesn't look like I qualify for anything else that would reduce my MAGI.

Is there something obvious that I might be missing besides the 401k?

If I thought I would be able to contribute to and then deduct my TIRA for many years to come I might be more inclined to consider the recharacterization of the Roth. Even if after a while I hit the limit and had to contribute post tax money to the TIRA and do a Roth pipeline later on in life. Maybe have a chance at reducing future taxes on today's contributions.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

retiredjg wrote:I think you should consider using Roth IRA, or at least some Roth IRA, even if you are eligible to deduct your tIRA contribution. Having both untaxed money (in your 401k) and already taxed money (in your Roth IRA) gives you some tax-diversification. Having both gives you some additional flexibility in retirement.

Also, the contributions to Roth IRA (but not the earnings) are available to you anytime without penalty. This gives you a back up to your emergency fund.
When I originally made the decision to open the Roth, "tax-diversification" was what I had in mind. As my previous posts on this topic have revealed, I'm pretty ignorant when it comes to a lot of this stuff but I thought if you try and diversify with stocks and bonds perhaps this technique could apply to taxes as well.

I always thought the access to the contributions was a very appealing aspect of the Roth. It's something that I will be heavily considering when I decide on what to do.

Hypothetical question: If someone draws solely from their Roth contributions (not earnings) during a year of early retirement, does that mean they have no taxable income that year?
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dodecahedron
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by dodecahedron »

ShimmyShuffle wrote:
Bob's not my name wrote:I don't see any issues with deductible TIRA eligibility. $70,000 of gross income probably puts your MAGI below $50,000, so you have lots of headroom.

In 2015 you're fully eligible if your MAGI is below $61,000. That probably equates to about $82,000 gross income. The 401k contribution limit and the deductible TIRA eligibility threshold are both inflation-adjusted, so the threshold recedes from you as your approach it.
Interesting, I figured I'd be above 50k because the only thing I really think would be deducted would be the 401k. I'm not really aware of what else I could use to reduce my MAGI. I checked some of the available info on the net, and it doesn't look like I qualify for anything else that would reduce my MAGI.

Is there something obvious that I might be missing besides the 401k?
You said above that you were maxing out your 401k contributions, that is $17,500 reduction in AGI right there (and will be $18,000 in 2015). If your income is $70K, and you really *are* maxing out your 401k, you should be comfortably below the deductible traditional IRA limit.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Bob's not my name wrote:Look at your W2 and page one of your 1040 to see what factors reduce your AGI. One big factor is pre-tax health, dental, and disability insurance premiums withheld from your pay. For many people this is a few thousand. Then there are health FSA contributions. And the 401k contribution limit will be $18,000 next year. So your AGI/MAGI ought to be at least $20,000 below your gross income.

If you're maxing your 401k and a Roth IRA it's probably fine to go with that mix. If you have a state tax too you are paying a lot of tax on your Roth IRA contribution (maybe $2,500), which is painful, but bear in mind that if you go with a traditional IRA you can't fit the whole $8,000 of gross pay into it, only $5,500 and then you still have $2,500 of gross pay that will be taxed willy nilly.
Whoops, missed this post. In my previous post I asked what you are answering here regarding the AGI/MAGI. Many thanks. I do live in NY so I'm hit with the state tax too. Are you saying for every 5,500 I'm contributing to that I'm paying 2,500 in taxes? Sorry if I'm not understanding this right.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

dodecahedron wrote:
ShimmyShuffle wrote:
Bob's not my name wrote:I don't see any issues with deductible TIRA eligibility. $70,000 of gross income probably puts your MAGI below $50,000, so you have lots of headroom.

In 2015 you're fully eligible if your MAGI is below $61,000. That probably equates to about $82,000 gross income. The 401k contribution limit and the deductible TIRA eligibility threshold are both inflation-adjusted, so the threshold recedes from you as your approach it.
Interesting, I figured I'd be above 50k because the only thing I really think would be deducted would be the 401k. I'm not really aware of what else I could use to reduce my MAGI. I checked some of the available info on the net, and it doesn't look like I qualify for anything else that would reduce my MAGI.

Is there something obvious that I might be missing besides the 401k?
You said above that you were maxing out your 401k contributions, that is $17,500 reduction in AGI right there (and will be $18,000 in 2015). If your income is $70K, and you really *are* maxing out your 401k, you should be comfortably below the deductible traditional IRA limit.
That's correct, I'm maxing it out at 17,500. I guess what I'm looking at is how close I was to the limit after all was said and done, and if it was worth switching the Roth to a TIRA to get the deduction now and maybe do a pipeline to a Roth later on in life. If in a few years my estimated salary increases would be putting me past the limit I didn't see the point.

To follow up on an earlier question, if I ended up with 50,000 MAGI and then contributed 5,500 to the TIRA I would still be at 50,000 MAGI because you add the TIRA contribution back in at the end right?
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

Yes. Assuming you're not in NYC, your state tax is, what, 6.85%? (I didn't bother to look it up.) If you don't itemize, then your marginal rate is about 32%. $5,500/0.68 = $8,088. That's how much gross income you consume to make a $5,500 Roth contribution; $2,588 is lost to income taxes. However, as I pointed out above, this calculation isn't really relevant to your "saturated" situation, in which you're already maxing your 401k, because you can't put $8,088 in a TIRA.

Also, in many major emergencies you can withdraw penalty-free from a TIRA, and maybe tax-free too, depending on the emergency. See http://thefinancebuff.com/your-traditio ... -fund.html

All that said, I don't think it's a mistake to choose Roth IRA if you're maxing your 401k. I don't really buy the tax diversification argument, but if you are successful in your career or if marriage substantially changes your income you may be ineligible for both Roth and deductible TIRA contributions, at which point the back door Roth is your only option, and the pro rata rule will make any TIRA a problem. So, at least under today's insane tax code, it may be better to keep things tidy with traditional 401k and Roth IRA only. I don't take this advice myself, though. My marginal rate has been 40-50% for many years, and I've always chosen to max my 401k and my wife's traditional IRA before making any Roth contributions. Just can't believe my tax rate on withdrawals in retirement is going to be that high.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote:To follow up on an earlier question, if I ended up with 50,000 MAGI and then contributed 5,500 to the TIRA I would still be at 50,000 MAGI because you add the TIRA contribution back in at the end right?
Sorta. MAGI has different definitions depending on the particular phaseout or credit. For deductible TIRA eligibility, the TIRA contributions don't affect your eligibility.
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retiredjg
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by retiredjg »

ShimmyShuffle wrote:Hypothetical question: If someone draws solely from their Roth contributions (not earnings) during a year of early retirement, does that mean they have no taxable income that year?
Yes. If you only take money from Roth (no pension, no SS, no nothing) there would be no tax.

But you wouldn't want to do that. You get a certain amount of income that is not taxed at all - the amount equal to your personal exemptions and your deductions. You wouldn't want to waste this space on Roth money (if you have a choice) because it won't be taxed anyway. Ideally, you'd have a small amount coming from tIRA or taxable to fill up that untaxed space - then take the rest from Roth.

This is just a hypothetical - most people do not withdraw from Roth early in retirement - because they want that Roth money to keep growing.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Yes. Assuming you're not in NYC, your state tax is, what, 6.85%? (I didn't bother to look it up.) If you don't itemize, then your marginal rate is about 32%. $5,500/0.68 = $8,088. That's how much gross income you consume to make a $5,500 Roth contribution; $2,588 is lost to income taxes. However, as I pointed out above, this calculation isn't really relevant to your "saturated" situation, in which you're already maxing your 401k, because you can't put $8,088 in a TIRA.


Sorry for my late reply. Hopefully you or someone else will still be able to clarify a few more things for me. I'm unsure as to how you get the .68. I thought I would have to look at it as 5,500 * .32 and then add the result to 5,500 to see what I'm losing out on in taxes. Math is not my strong suit. Also, I'm in the city so it seems my marginal tax rate is around 35% if I'm understanding things right.

I think I'd be better off starting a TIRA, and letting the Roth sit. If I end up exceeding the deductibility limits for the TIRA a few years down the road. I can just start funding my Roth again.

This might sound weird, but I'm bothered by the thought of having the Roth sit there while I fund the TIRA, and vice versa. I just don't see the point of splitting the contributions. I'd definitely want the full 5,500 in the TIRA for the tax break.
All that said, I don't think it's a mistake to choose Roth IRA if you're maxing your 401k. I don't really buy the tax diversification argument, but if you are successful in your career or if marriage substantially changes your income you may be ineligible for both Roth and deductible TIRA contributions, at which point the back door Roth is your only option, and the pro rata rule will make any TIRA a problem.
In light of my currently high tax rate, are the current tax savings worth the risk of possible future complications of the pro rata rule? It's unlikely I'll ever hit the income limits for contributing to a Roth. Also, I'm going to need to read up on the pro rata rule and back door Roth, but would this also cause complications for a Roth conversion pipeline? Are the back door and the pipeline the same thing, similar or completely different?
Last edited by ShimmyShuffle on Thu Nov 20, 2014 10:39 pm, edited 1 time in total.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

retiredjg wrote:
ShimmyShuffle wrote:Hypothetical question: If someone draws solely from their Roth contributions (not earnings) during a year of early retirement, does that mean they have no taxable income that year?
Yes. If you only take money from Roth (no pension, no SS, no nothing) there would be no tax.

But you wouldn't want to do that. You get a certain amount of income that is not taxed at all - the amount equal to your personal exemptions and your deductions. You wouldn't want to waste this space on Roth money (if you have a choice) because it won't be taxed anyway. Ideally, you'd have a small amount coming from tIRA or taxable to fill up that untaxed space - then take the rest from Roth.

This is just a hypothetical - most people do not withdraw from Roth early in retirement - because they want that Roth money to keep growing.

Thank you. That makes a lot of sense.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by kaneohe »

dodecahedron wrote: As for your question about recharacterization, yes it is possible, but it's a pain in the posterior. (My husband and I did something like this once, when we had accidentally overcontributed to an SEP-IRA, but it was a paperwork hassle and I have resolved to avoid such things in the future. Life is too short to spend time dealing with stuff like that.)
http://www.investopedia.com/articles/re ... 092403.asp
OP should talk to IRA custodian about this. Schwab, for example, will do the calculation if requested and the form is a simple 2 pg thing requiring answering a few questions
which, in my opinion, makes the whole affair quite trivial requiring just a few minutes of time.
Bob's not my name
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote:
Yes. Assuming you're not in NYC, your state tax is, what, 6.85%? (I didn't bother to look it up.) If you don't itemize, then your marginal rate is about 32%. $5,500/0.68 = $8,088. That's how much gross income you consume to make a $5,500 Roth contribution; $2,588 is lost to income taxes. However, as I pointed out above, this calculation isn't really relevant to your "saturated" situation, in which you're already maxing your 401k, because you can't put $8,088 in a TIRA.
Sorry for my late reply. Hopefully you or someone else will still be able to clarify a few more things for me. I'm unsure as to how you get the .68. I thought I would have to look at it as 5,500 * .32 and then add the result to 5,500 to see what I'm losing out on in taxes. Math is not my strong suit. Also, I'm in the city so it seems my marginal tax rate is around 35% if I'm understanding things right.
You're doing the math upside down. If your marginal rate is 35% then you need $8,461 of gross income to yield $5,500 of net income, because $2,961 is lost to taxes. As I also explained, that doesn't mean, in your saturated case (maxing the 401k), that you could alternatively shelter $8,461 in a traditional IRA, because there's a $5,500 limit. So the traditional IRA won't save you $2,961 in taxes. If you weren't maxing your 401k you could in fact shelter the whole $8,461 and save $2,961 in taxes. But since you have only $5,500 of space you have to look at the $8,461 slug of gross income this way:

$5,500 can be sheltered in the TIRA, saving $5,500 * .35 of taxes = $1,925
$2,961 can't be sheltered because you've maxed all your pre-tax space for the year, so that gets taxed: $2,961 * .35 = $1,036 of taxes
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote:I'm going to need to read up on the pro rata rule and back door Roth, but would this also cause complications for a Roth conversion pipeline? Are the back door and the pipeline the same thing, similar or completely different?
I don't know what a Roth conversion pipeline is.
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retiredjg
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by retiredjg »

Bob's not my name wrote:
ShimmyShuffle wrote:I'm going to need to read up on the pro rata rule and back door Roth, but would this also cause complications for a Roth conversion pipeline? Are the back door and the pipeline the same thing, similar or completely different?
I don't know what a Roth conversion pipeline is.
I don't either, but this is the 3rd reference to a "pipeline that I've run across recently (here at Bogleheads). I'm wondering if someone made up a new term and used it in an article or something.
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ShimmyShuffle
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

kaneohe wrote:
dodecahedron wrote: As for your question about recharacterization, yes it is possible, but it's a pain in the posterior. (My husband and I did something like this once, when we had accidentally overcontributed to an SEP-IRA, but it was a paperwork hassle and I have resolved to avoid such things in the future. Life is too short to spend time dealing with stuff like that.)
http://www.investopedia.com/articles/re ... 092403.asp
OP should talk to IRA custodian about this. Schwab, for example, will do the calculation if requested and the form is a simple 2 pg thing requiring answering a few questions
which, in my opinion, makes the whole affair quite trivial requiring just a few minutes of time.
Thanks, I may look into this. Depending on what it would cost me to speak to someone about this, it might be worth it if I could then recharacterize and reduce my 2014 tax bill by 5500. If I don't do this, I'll just start and max a 2015 TIRA.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

You're doing the math upside down. If your marginal rate is 35% then you need $8,461 of gross income to yield $5,500 of net income, because $2,961 is lost to taxes. As I also explained, that doesn't mean, in your saturated case (maxing the 401k), that you could alternatively shelter $8,461 in a traditional IRA, because there's a $5,500 limit. So the traditional IRA won't save you $2,961 in taxes. If you weren't maxing your 401k you could in fact shelter the whole $8,461 and save $2,961 in taxes. But since you have only $5,500 of space you have to look at the $8,461 slug of gross income this way:

$5,500 can be sheltered in the TIRA, saving $5,500 * .35 of taxes = $1,925
$2,961 can't be sheltered because you've maxed all your pre-tax space for the year, so that gets taxed: $2,961 * .35 = $1,036 of taxes
While I still have no idea where the .68 in the original equation comes from and how I need $8,461 of gross to yield $5,500, I trust you know why. What I can grasp is that I'm really only reducing my tax bill by 1,925 minus the 1,036. I'm not actually saving the full $1,925, which is what I thought. If I'm wrong on that let me know. This still makes the TIRA a better option.
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tainted-meat
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by tainted-meat »

This is a very good thread. Shimmy is in that "sweet spot" where you can do a 401k and a Traditional IRA and defer some serious taxes. 'Not Bob' has had some great threads on this that are very helpful.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

I don't know what a Roth conversion pipeline is.
I don't either, but this is the 3rd reference to a "pipeline that I've run across recently (here at Bogleheads). I'm wondering if someone made up a new term and used it in an article or something.
I'll probably explain this poorly, but it's basically taking money from a TIRA and converting a certain amount each year to a Roth. As a hypothetical example: I take 10,000 dollars this year from a TIRA > convert it to a Roth > pay income taxes on that 10k this year and then have full access to it (contributions not earnings) 5 years from now. You can then do a "ladder" if you wanted to retire early by doing this annually and each year you'd have that 10k available to you once you hit the 5 year mark of the original conversion.

Maybe this is the same thing as a back door, I don't know. The term pipeline is common for it though. From what I read about the pro rata rules a few weeks ago when they were first mentioned here, is that if you're trying to convert money from the TIRA to a Roth the accounting gets very tricky because it forces you to estimate tax owed based on all of your IRAs not just the amount you're converting.

The term pipeline is mentioned here: http://www.bogleheads.org/forum/viewtop ... &p=2008066

I also saw a lot of people calling it a pipeline in this article which is where I think I originally read about this strategy: http://www.madfientist.com/retire-even-earlier/

Perhaps the problem of the pro rata rule only arises when your income is exceeding the limits for the deductible IRA and the Roth?
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Carl53 »

Bob's not my name wrote:Yes. Assuming you're not in NYC, your state tax is, what, 6.85%? (I didn't bother to look it up.) If you don't itemize, then your marginal rate is about 32%. $5,500/0.68 = $8,088.
ShimmyShuffle wrote:
While I still have no idea where the .68 in the original equation comes from and how I need $8,461 of gross to yield $5,500, I trust you know why. What I can grasp is that I'm really only reducing my tax bill by 1,925 minus the 1,036. I'm not actually saving the full $1,925, which is what I thought. If I'm wrong on that let me know. This still makes the TIRA a better option.
100% - 25% - 6.85% = 68.15% I assume that it was established above that you are in the nominal 25% federal tax bracket and that he is assuming that your state tax bracket is 6.85% (about 7%).
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

ShimmyShuffle wrote:
kaneohe wrote:
dodecahedron wrote: As for your question about recharacterization, yes it is possible, but it's a pain in the posterior. (My husband and I did something like this once, when we had accidentally overcontributed to an SEP-IRA, but it was a paperwork hassle and I have resolved to avoid such things in the future. Life is too short to spend time dealing with stuff like that.)
http://www.investopedia.com/articles/re ... 092403.asp
OP should talk to IRA custodian about this. Schwab, for example, will do the calculation if requested and the form is a simple 2 pg thing requiring answering a few questions
which, in my opinion, makes the whole affair quite trivial requiring just a few minutes of time.
Thanks, I may look into this. Depending on what it would cost me to speak to someone about this, it might be worth it if I could then recharacterize and reduce my 2014 tax bill by 5500. If I don't do this, I'll just start and max a 2015 TIRA.
Whoops, I see my deadline for trying the recharacterization of the 2014 Roth was 10/15.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by retiredjg »

ShimmyShuffle wrote:
I don't know what a Roth conversion pipeline is.
I don't either, but this is the 3rd reference to a "pipeline that I've run across recently (here at Bogleheads). I'm wondering if someone made up a new term and used it in an article or something.
I'll probably explain this poorly, but it's basically taking money from a TIRA and converting a certain amount each year to a Roth. As a hypothetical example: I take 10,000 dollars this year from a TIRA > convert it to a Roth > pay income taxes on that 10k this year and then have full access to it (contributions not earnings) 5 years from now. You can then do a "ladder" if you wanted to retire early by doing this annually and each year you'd have that 10k available to you once you hit the 5 year mark of the original conversion.
Thanks. Sounds nifty, but probably not really a good idea for a lot of people to be doing all that converting before retirement when you tax rate is likely higher.
Maybe this is the same thing as a back door, I don't know.
They are not the same, but both maneuvers contain a conversion to Roth IRA. With the back door, you make a non-deductible contribution to tIRA and convert it to Roth IRA. It is a way for people who can't contribute directly to Roth IRA (they make too much money) to get money into Roth IRA.


From what I read about the pro rata rules a few weeks ago when they were first mentioned here, is that if you're trying to convert money from the TIRA to a Roth the accounting gets very tricky because it forces you to estimate tax owed based on all of your IRAs not just the amount you're converting.
It is not an estimation. It's a calculation. If you have both deductible and non-deductible contributions, you can't just pick the non-deductible part and convert that to Roth without paying tax. You pay tax based on the percentage of your IRA money that is non-deductible. So if 10% of your IRA money has already been taxed (non-deductible contributions), then 10% of anything you convert is considered already taxed and you pay tax on the other 90%.


Perhaps the problem of the pro rata rule only arises when your income is exceeding the limits for the deductible IRA and the Roth?
No, it applies to all conversions of tIRA to Roth IRA.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote:
You're doing the math upside down. If your marginal rate is 35% then you need $8,461 of gross income to yield $5,500 of net income, because $2,961 is lost to taxes. As I also explained, that doesn't mean, in your saturated case (maxing the 401k), that you could alternatively shelter $8,461 in a traditional IRA, because there's a $5,500 limit. So the traditional IRA won't save you $2,961 in taxes. If you weren't maxing your 401k you could in fact shelter the whole $8,461 and save $2,961 in taxes. But since you have only $5,500 of space you have to look at the $8,461 slug of gross income this way:

$5,500 can be sheltered in the TIRA, saving $5,500 * .35 of taxes = $1,925
$2,961 can't be sheltered because you've maxed all your pre-tax space for the year, so that gets taxed: $2,961 * .35 = $1,036 of taxes
What I can grasp is that I'm really only reducing my tax bill by 1,925 minus the 1,036. I'm not actually saving the full $1,925, which is what I thought. If I'm wrong on that let me know. This still makes the TIRA a better option.
You still have it wrong. Read my post again.
$5,500 can be sheltered in the TIRA, saving $5,500 * .35 of taxes = $1,925
It's illogical to subtract all of the taxes you will still pay from the tax savings of the TIRA contribution. If you do that you'll arrive at the conclusion that an TIRA will cost you $20,000 in taxes.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Carl53 wrote:
Bob's not my name wrote:Yes. Assuming you're not in NYC, your state tax is, what, 6.85%? (I didn't bother to look it up.) If you don't itemize, then your marginal rate is about 32%. $5,500/0.68 = $8,088.
ShimmyShuffle wrote:
While I still have no idea where the .68 in the original equation comes from and how I need $8,461 of gross to yield $5,500, I trust you know why. What I can grasp is that I'm really only reducing my tax bill by 1,925 minus the 1,036. I'm not actually saving the full $1,925, which is what I thought. If I'm wrong on that let me know. This still makes the TIRA a better option.
100% - 25% - 6.85% = 68.15% I assume that it was established above that you are in the nominal 25% federal tax bracket and that he is assuming that your state tax bracket is 6.85% (about 7%).
Thanks for the very clear explanation. Could I use this formula (numbers would be slightly different because I also pay NYC tax) to calculate a more accurate cost of other purchases I make?
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Bob's not my name wrote:
ShimmyShuffle wrote:
You're doing the math upside down. If your marginal rate is 35% then you need $8,461 of gross income to yield $5,500 of net income, because $2,961 is lost to taxes. As I also explained, that doesn't mean, in your saturated case (maxing the 401k), that you could alternatively shelter $8,461 in a traditional IRA, because there's a $5,500 limit. So the traditional IRA won't save you $2,961 in taxes. If you weren't maxing your 401k you could in fact shelter the whole $8,461 and save $2,961 in taxes. But since you have only $5,500 of space you have to look at the $8,461 slug of gross income this way:

$5,500 can be sheltered in the TIRA, saving $5,500 * .35 of taxes = $1,925
$2,961 can't be sheltered because you've maxed all your pre-tax space for the year, so that gets taxed: $2,961 * .35 = $1,036 of taxes
What I can grasp is that I'm really only reducing my tax bill by 1,925 minus the 1,036. I'm not actually saving the full $1,925, which is what I thought. If I'm wrong on that let me know. This still makes the TIRA a better option.
You still have it wrong. Read my post again.
$5,500 can be sheltered in the TIRA, saving $5,500 * .35 of taxes = $1,925
It's illogical to subtract all of the taxes you will still pay from the tax savings of the TIRA contribution. If you do that you'll arrive at the conclusion that an TIRA will cost you $20,000 in taxes.
I've read it numerous times and still don't know exactly what you mean. For simplicity's sake, contributing to a fully deductible TIRA in 2015 will save me 1,925 if my marginal tax rate was 35% right? I'll need to continue reading and researching to understand the other point you're trying to make regarding $2,961 not being sheltered. Maybe it's not important since you say it's really not relevant to my "saturated" situation.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Thanks. Sounds nifty, but probably not really a good idea for a lot of people to be doing all that converting before retirement when you tax rate is likely higher.
Yeah, it's really supposed to be done when you're in early retirement or other situation where you would keep taxes as low as possible. I'm pretty sure I've read some people using this method, possibly in conjunction with others, to completely avoid paying taxes on the conversion amounts from the 401k > IRA > Roth.
No, it applies to all conversions of tIRA to Roth IRA.
I'm surprised I've never heard about the pro rata rule prior to this thread. I'm glad I did because it seems like something that is worth researching to understand better if one is planning on relying heavily on the pipeline conversions.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by dodecahedron »

tainted-meat wrote:This is a very good thread. Shimmy is in that "sweet spot" where you can do a 401k and a Traditional IRA and defer some serious taxes. 'Not Bob' has had some great threads on this that are very helpful.
After tainted-meat posted this, Shimmy provided information that further sweetens the sweet spot. He mentioned (in passing) that he is also subject to NYC tax.

In light of this, I'd say all factors *strongly* weigh in favor of Traditional at this point: Federal, state, and city tax breaks upfront on traditional contributions. (Plus NY and NYC provide some back end tax breaks to distributions from retirement plans after age 59.5. Many other states do as well so if he is planning to move out of NY/NYC, he has many other options which would tax his distributions from deferred plans lightly.)
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote: I'll need to continue reading and researching to understand the other point you're trying to make regarding $2,961 not being sheltered. Maybe it's not important since you say it's really not relevant to my "saturated" situation.
Right. Most people can't fill all their tax-advantaged space. Such a person ("non-saturated case") could make a $8,461 additional contribution to his 401k or split it between his 401k and TIRA, for the same cost as making a $5,500 Roth IRA contribution.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by retiredjg »

ShimmyShuffle wrote:I'm pretty sure I've read some people using this method, possibly in conjunction with others, to completely avoid paying taxes on the conversion amounts from the 401k > IRA > Roth.
I suspect a misunderstanding. There is very little money that does not get taxed at some point, either going into an account or coming out.
No, it applies to all conversions of tIRA to Roth IRA.
I'm surprised I've never heard about the pro rata rule prior to this thread. I'm glad I did because it seems like something that is worth researching to understand better if one is planning on relying heavily on the pipeline conversions.
Download a Form 8606 and pencil in some non-deductible money (front side) and a conversion (back side). When you get to line 6, you'll see where it asks for the balance of all tIRA, SIMPLE IRA, and SEP IRA (you'll have to make one up that contains deductible contributions). As you go on down the page you'll see how all that money works into the calculations.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

dodecahedron wrote:
tainted-meat wrote:This is a very good thread. Shimmy is in that "sweet spot" where you can do a 401k and a Traditional IRA and defer some serious taxes. 'Not Bob' has had some great threads on this that are very helpful.
After tainted-meat posted this, Shimmy provided information that further sweetens the sweet spot. He mentioned (in passing) that he is also subject to NYC tax.

In light of this, I'd say all factors *strongly* weigh in favor of Traditional at this point: Federal, state, and city tax breaks upfront on traditional contributions. (Plus NY and NYC provide some back end tax breaks to distributions from retirement plans after age 59.5. Many other states do as well so if he is planning to move out of NY/NYC, he has many other options which would tax his distributions from deferred plans lightly.)
Yep, and while I'm not overly upset because I'm still going to reap tax benefits from my 2014 Roth contribution... I could kick myself in the throat for not catching this in time for the 10/15 deadline date to recharacterize my Roth contribution as Traditional. This thread has been quite an eye-opener for me, so thanks very much to everyone here for all their insights so far.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by powermega »

retiredjg wrote:I think you should consider using Roth IRA, or at least some Roth IRA, even if you are eligible to deduct your tIRA contribution. Having both untaxed money (in your 401k) and already taxed money (in your Roth IRA) gives you some tax-diversification. Having both gives you some additional flexibility in retirement.

Also, the contributions to Roth IRA (but not the earnings) are available to you anytime without penalty. This gives you a back up to your emergency fund.
This. You want to have money in Roth and non-Roth retirement accounts. When it comes time to take money out of those accounts in retirement, you'll have the advantage of being able to take money out of one account vs. another to minimize taxes. JMO, but I would continue to max out Roth IRA contributions every year in addition to the 401k.
Even a stopped clock is right twice a day.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

powermega wrote:
retiredjg wrote:I think you should consider using Roth IRA, or at least some Roth IRA, even if you are eligible to deduct your tIRA contribution. Having both untaxed money (in your 401k) and already taxed money (in your Roth IRA) gives you some tax-diversification. Having both gives you some additional flexibility in retirement.

Also, the contributions to Roth IRA (but not the earnings) are available to you anytime without penalty. This gives you a back up to your emergency fund.
This. You want to have money in Roth and non-Roth retirement accounts. When it comes time to take money out of those accounts in retirement, you'll have the advantage of being able to take money out of one account vs. another to minimize taxes. JMO, but I would continue to max out Roth IRA contributions every year in addition to the 401k.
\

This is another reason I'm not too upset I started the Roth account. I think the tax savings I'll get now, though, force my hand at maxing the Traditional. I'm kind of thinking my salary is going to increase to the point within the next few years that it will put me at the limit for the deductible IRA, at least partially. At that point I'll split the contributions between the two, putting only up to the deductible amount into the Traditional. I think the Roth is really an amazing account that offers some added flexibility, but I'm willing to bet it's better to reduce my tax bill now since my rate will probably be lower later on in life.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote:I'm kind of thinking my salary is going to increase to the point within the next few years that it will put me at the limit for the deductible IRA
Bob's not my name wrote:I don't see any issues with deductible TIRA eligibility. $70,000 of gross income probably puts your MAGI below $50,000, so you have lots of headroom.

In 2015 you're fully eligible if your MAGI is below $61,000. That probably equates to about $82,000 gross income. The 401k contribution limit and the deductible TIRA eligibility threshold are both inflation-adjusted, so the threshold recedes from you as your approach it.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Bob's not my name wrote:
ShimmyShuffle wrote:I'm kind of thinking my salary is going to increase to the point within the next few years that it will put me at the limit for the deductible IRA
Bob's not my name wrote:I don't see any issues with deductible TIRA eligibility. $70,000 of gross income probably puts your MAGI below $50,000, so you have lots of headroom.

In 2015 you're fully eligible if your MAGI is below $61,000. That probably equates to about $82,000 gross income. The 401k contribution limit and the deductible TIRA eligibility threshold are both inflation-adjusted, so the threshold recedes from you as your approach it.
Not exactly sure why you're reposting that, or if you meant to type something after the quotes. I've been floored by the past few raises I've received, and it's entirely possible I might hit those types of numbers within the next 3-5 years. Although I tend to keep my expectations low as to not get disappointed. Even when taking into account the deductibility limits being inflation-adjusted, there's a chance I could hit the limit and either be stuck with a partial deduction or none at all.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Download a Form 8606 and pencil in some non-deductible money (front side) and a conversion (back side). When you get to line 6, you'll see where it asks for the balance of all tIRA, SIMPLE IRA, and SEP IRA (you'll have to make one up that contains deductible contributions). As you go on down the page you'll see how all that money works into the calculations
.

Thanks much for the suggestion. I'm sure I'll play around with that soon.

I found something I thought was interesting when researching the pro rata rule tonight. If someone is trying to do a backdoor Roth but has a large pretax IRA messing things up for them, they can (if the option is available) roll that into a 401k plan or a solo/self employed 401k. That will remove the pretax money from the equation.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by Bob's not my name »

ShimmyShuffle wrote:There's a strong possibility my income could increase to 80k give or take a few k within the next 5 years.
That would put you still under the phaseout. If in five years the TIRA phaseout starts at $65,000 and the 401k limit is $19,000 and you have $2,000 of pre-tax insurance premiums then the gross income equivalent will be $86,000, which is still above "80k give or take a few k." Of course in five years the tax code may look totally different, too.
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Re: Questions About 401k and AGI and Traditional vs Roth IRA

Post by ShimmyShuffle »

Bob's not my name wrote:
ShimmyShuffle wrote:There's a strong possibility my income could increase to 80k give or take a few k within the next 5 years.
That would put you still under the phaseout. If in five years the TIRA phaseout starts at $65,000 and the 401k limit is $19,000 and you have $2,000 of pre-tax insurance premiums then the gross income equivalent will be $86,000, which is still above "80k give or take a few k." Of course in five years the tax code may look totally different, too.
You're right, I forgot about the 401k limits increasing as well. When I said 80k give or take a few k I was thinking I could end up with a bonus of a few grand and overtime totaling another few grand which could make things unpredictable, but your explanation puts me at ease. Thanks again.
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