IRA vs Roth IRA

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deikel
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IRA vs Roth IRA

Post by deikel » Wed Feb 19, 2014 5:35 pm

Stupid question coming up:

2013 is the first year we (wife and I married filing jointly) added contribution to IRA account. Sounded good and we could save some taxes - always appreciated.

Turbo Tax lets me know that we can only deduct about 5000k each of the 5500k allowed since income is getting too high for the full amount. OK, not a problem, everything counts and its done by now (so too late for changes)

In hindside, I realize that its a question of paying taxes either now or in the future when taking out, so it turns out that my current tax rate is 8% federal (as per TurboTax), but many seem to suggest that its only worthwhile to do IRA over Roth IRA if you pay are at least in the 15% tax bracket.

Now, this has me puzzled. In order to get into the 15 % bracket for tax to make the IRA useful I would have to earn much more money...which would make me uneligable for the full IRA deduction.....???

Also, if I only pay 8 % taxes now, would I not pay rather less in retirement when I only take out 40k in todays dollars vs our combined 120k income

Something in my thinking seems not right, can someone please push my brian along ? Maybe the 15% tax bracket has a different definition than is obvious to me. Thanks.
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Peter Foley
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Re: IRA vs Roth IRA

Post by Peter Foley » Wed Feb 19, 2014 5:46 pm

Turbo tax calculates your average tax rate. The Roth versus TIRA conundrum is based on an analysis of one's marginal tax rate. The top of the 15% bracket for married filing jointly in 2013 is $72,500 in taxable income (approximately $90,000 - $95,000 in adjusted gross income). If your taxable income is above $72,000 you pay 25% tax on those dollars until you reach the next tax bracket.

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damjam
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Re: IRA vs Roth IRA

Post by damjam » Wed Feb 19, 2014 5:58 pm

Try using the Tax Bracket Calculator to figure out your bracket.
Hint: there is no 8% tax bracket.

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kenyan
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Re: IRA vs Roth IRA

Post by kenyan » Wed Feb 19, 2014 6:03 pm

deikel wrote:Stupid question coming up:

2013 is the first year we (wife and I married filing jointly) added contribution to IRA account. Sounded good and we could save some taxes - always appreciated.

Turbo Tax lets me know that we can only deduct about 5000k each of the 5500k allowed since income is getting too high for the full amount. OK, not a problem, everything counts and its done by now (so too late for changes)

In hindside, I realize that its a question of paying taxes either now or in the future when taking out, so it turns out that my current tax rate is 8% federal (as per TurboTax), but many seem to suggest that its only worthwhile to do IRA over Roth IRA if you pay are at least in the 15% tax bracket.

Now, this has me puzzled. In order to get into the 15 % bracket for tax to make the IRA useful I would have to earn much more money...which would make me uneligable for the full IRA deduction.....???

Also, if I only pay 8 % taxes now, would I not pay rather less in retirement when I only take out 40k in todays dollars vs our combined 120k income

Something in my thinking seems not right, can someone please push my brian along ? Maybe the 15% tax bracket has a different definition than is obvious to me. Thanks.


For clarity, you should refer to a 'regular' IRA as a Traditional IRA or TIRA. A Roth IRA is type of IRA too (and there are others).

Don't confuse average tax rate with marginal tax rate. There is no 8% marginal bracket. The lowest marginal tax bracket is 10%. You paid 8% of your gross income, but that's due to the various deductions, credits, exemptions, that you claimed (the '0% bracket'). Your TIRA benefited you to the tune of 15% - or maybe even 25% - of the deductible part of your contribution, because it is subtracted from your gross income to help determine your AGI.

If you want to know your marginal tax bracket, look up your taxable income (1040 line 43). For 2013, MFJ, the 15% bracket was $17851-72500. The 25% bracket was $72501-146400.
Retirement investing is a marathon.

retiredjg
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Re: IRA vs Roth IRA

Post by retiredjg » Wed Feb 19, 2014 6:07 pm

Agreed. You need to figure out your tax bracket.

That is not the same as the 8% that TT is telling you - they are talking about "effective rate". If I make $1000, then $80 goes to tax. But taxes don't work that way. Some of that $1,000 is not taxed, some at 10%, some at 15%, some at 25%, on up the line.

The calculator posted earlier asks for your TAXABLE income. That is line 43 of form 1040. If you don't use 1040, find the line with the words "taxable income" and use that number.

Once you know your tax bracket, people can help you with your question.

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damjam
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Re: IRA vs Roth IRA

Post by damjam » Wed Feb 19, 2014 6:18 pm

The tax bracket question comes up often enough that I wonder why there is no WIKI page to explain it. Or did I just miss it?

Sorry, don't mean to hijack the thread.

dickenjb
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Re: IRA vs Roth IRA

Post by dickenjb » Wed Feb 19, 2014 6:26 pm

And even if you are limited to $5000 each to a deductible Traditional IRA, you still have until April 15th to each put $500 for 2013 into a Roth IRA.

deikel
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Re: IRA vs Roth IRA

Post by deikel » Wed Feb 19, 2014 8:30 pm

kenyan wrote:
deikel wrote:

If you want to know your marginal tax bracket, look up your taxable income (1040 line 43). For 2013, MFJ, the 15% bracket was $17851-72500. The 25% bracket was $72501-146400.


Ah, now I got it and I am in the 15 % bracket, so the TIRA is not all that stupid after all.

Thanks again !
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Karamatsu
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Re: IRA vs Roth IRA

Post by Karamatsu » Wed Feb 19, 2014 8:46 pm

So yes, as people have said, what TT is telling you is your effective tax rate: the tax you paid divided by your gross income before deductions, exemptions, credits, etc. Chances are if you're on the borderline for an IRA contribution, your marginal tax rate is 28%, though it could be higher. The marginal rate tells you, "If I added one more dollar of income, how much would go out in taxes," so if your marginal rate is 28%, it would be 28 cents on the dollar.

What matters for the Traditional/Roth decision is a comparison between your marginal rate today versus your marginal rate when you retire. If it's higher now than it will be in retirement, then in the simplest case, where you just keep the money in the IRA in cash, it can be advantageous to put money into a Traditional IRA, take the deduction, and then pay taxes later. In the reverse case, where your rates are lower now than they will be when you retire (which can happen if you have a lot of deductions and credits now that you won't have later) it's better to pay the low tax now and put the after-tax money into a Roth, so you'll pay no tax on withdrawals.

But the truth nobody keeps their IRA money in cash. Well, some people do. But let's not. If you invest it, and your investments do well, it can be advantageous to use a Roth even if you're in a higher bracket now than you will be later because with a Roth you pay no taxes on your investment gains, while traditional IRAs have minimum required distributions that can push you into a higher bracket. And there is also the effect of inflation, which affects not only the real buying power of your investments but the tax bracket lines as well. A lot of people see all this and prefer the Roth structure from the beginning. It's undeniably simpler, and has some other perks as well, but you have to look at them side-by-side and compare. There are lots of calculators, like this one, on-line that can simulate different results for you.

Note that there is an exception to the use of marginal rates, which is if your effective tax rate (before any IRA deduction) is 0. In such a case your supposed marginal rate doesn't matter and, since you're paying no tax now, there's no advantage in taking the deduction, so it's way better to use a Roth. Not many people are in the position to pay zero taxes, but it can happen if you have a lot of credits and aren't liable for AMT.

The other thing to note, if you decide that a Roth would be better for you, is that, for the 2013 contribution, you have until April 15th 2014 to change your mind. If you'd rather put the $5000 into a Roth, you just have to file a form with the custodian "recharacterizing" your contribution from one account to the other. Just beware that the contribution limit rules for a Roth are different, so check carefully.

And then to complicate things even more, if you decide that a tIRA is best in the end, you can also contribute the remaining $500 to the tIRA as long as you treat it as non-deductible. That involves not taking a deduction on that additional $500, and also filing Form 8606.

I don't know why they decided to make all this so complex!

retiredjg
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Re: IRA vs Roth IRA

Post by retiredjg » Wed Feb 19, 2014 8:52 pm

Something does not seem right here.

If you are in or near the 15% bracket, I can't see how Turbo tax would tell you that you can only deduct $5,000 of your $5,500 contribution to tIRA. I could be wrong, but I don't think those two situations (15% bracket and can't deduct your full tIRA) are near each other in terms of taxable income.

If you really are in the 15% bracket and can stay in the 15% bracket while contributing to Roth (instead of tIRA), Roth might be a better choice.

But you said it was already done, so I would not worry about it. However, I think you might have some stuff to figure out cause something does not seem right to me.

DSInvestor
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Re: IRA vs Roth IRA

Post by DSInvestor » Wed Feb 19, 2014 9:10 pm

retiredjg wrote:Something does not seem right here.

If you are in or near the 15% bracket, I can't see how Turbo tax would tell you that you can only deduct $5,000 of your $5,500 contribution to tIRA. I could be wrong, but I don't think those two situations (15% bracket and can't deduct your full tIRA) are near each other in terms of taxable income.

If you really are in the 15% bracket and can stay in the 15% bracket while contributing to Roth (instead of tIRA), Roth might be a better choice.

But you said it was already done, so I would not worry about it. However, I think you might have some stuff to figure out cause something does not seem right to me.


If both spouses are covered by an employer plan, the MAGI to fully deduct Traditional IRA is <95K. Phase out applies if MAGI >95K. 95K AGI/MAGI could put OP in 15% bracket if they itemize deductions and/or have more than 2 exemptions.

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kenyan
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Re: IRA vs Roth IRA

Post by kenyan » Thu Feb 20, 2014 9:47 am

DSInvestor wrote:
retiredjg wrote:Something does not seem right here.

If you are in or near the 15% bracket, I can't see how Turbo tax would tell you that you can only deduct $5,000 of your $5,500 contribution to tIRA. I could be wrong, but I don't think those two situations (15% bracket and can't deduct your full tIRA) are near each other in terms of taxable income.

If you really are in the 15% bracket and can stay in the 15% bracket while contributing to Roth (instead of tIRA), Roth might be a better choice.

But you said it was already done, so I would not worry about it. However, I think you might have some stuff to figure out cause something does not seem right to me.


If both spouses are covered by an employer plan, the MAGI to fully deduct Traditional IRA is <95K. Phase out applies if MAGI >95K. 95K AGI/MAGI could put OP in 15% bracket if they itemize deductions and/or have more than 2 exemptions.


Makes sense. MAGI of 96K - 5K TIRA deduction = AGI of 91K. 91K - 72500 (to reach the 15% bracket) = 18500 worth of exemptions and deductions, not really that much.
Retirement investing is a marathon.

retiredjg
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Re: IRA vs Roth IRA

Post by retiredjg » Thu Feb 20, 2014 10:37 am

Ok. I can see now how that could happen. Thanks. :happy

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hoppy08520
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Re: IRA vs Roth IRA

Post by hoppy08520 » Thu Feb 20, 2014 6:37 pm

damjam wrote:The tax bracket question comes up often enough that I wonder why there is no WIKI page to explain it. Or did I just miss it?

Actually, there is a pretty good wiki page that explains this: marginal tax rate.

I just added a "redirect" page so if someone searches "tax bracket" it will automatically take them to that page.

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