Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

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Topic Author
Enganerd
Posts: 239
Joined: Wed Apr 15, 2015 8:22 pm

Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by Enganerd »

I think I messed up the Roth IRA vs tIRA decision for 2018. I believe we can recharacterize our contributions if we already maxed our Roths (is that correct?). I’m posting for a quick review of my thought process as I am far from as knowledgeable about investing/ taxes as many in this community. Thanks!

My wife and I will gross ~150k in 2018 (counting w2 salaries, interest and dividends)
We fully max a 457 and 403b: 37k
2 HSAs: 6.9K
Pension Contribution 5.25K
Std Deduction: 24K
If we did tIRAs: 11k
That gives a taxable income of: 150-37-6.9-5.25-24-11= 65.85K
This is 11K below the 0% capital gains tax bracket max: 77.2K

Therefore I can sell 11K of my amerifunds in a taxable vanguard account and buy an index fund without paying capital gains. Does that sound right? So I should therefore convert my roth IRA to traditional for this year? To understand exactly how much I am saving I need to know how much capital gains I owe per share.

The 3 amerifunds I have that I would like to eliminate are: CWGIX (34% US, 58% INT, 6% Cash), AGTHX (78 US, 13.% INT Large Cap + Growth Fund), and AWSHX (85% US, 10% INT Large Cap Blend)

I’ll probably leave the INT fund because I feel there is more justification for active management in international than domestic stocks. So that leaves AGTHX vs AWSHX and it looks like on a per share basis I owe more taxes on AGTHX so I think that is the one I will sell $11k worth of shares. Does this analysis look correct?

Current price: $51.43/share
My average cost: $29.32/share
If I sell $11k and get taxed at 0% vs 15% I save:
11*(1-29.32/51.43)*.15= ~$700. That would probably be worth the extra tIRA accounts I would guess.

Are there reasons not to do this? Right now my wife and I only have Roth IRAs so adding a traditional is adding a bit of complexity but no big deal for saving tax money (depends on how much) and getting some $ out of funds we would prefer not owning.
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jimb_fromATL
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Re: Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by jimb_fromATL »

It does not sound like you messed up to me. If I were in your situation, I'd be very happy that I could afford to invest so much, and I'd keep right on maxing the Roth IRAs every year as long as I could. I'd keep the existing taxable accounts, but might invest any future spare after-tax money in index funds.

Here are some of the reasons why:

Nobody knows how tax laws may change in the future, but as they stand now, one of the best ways to hedge your bets when you're eligible for Roth IRAs is to contribute the max to them every year that it is allowed and you can afford it.

That's probably even more true for you than for some folks because you are already maxing two tax-deferred plans, PLUS have a pension. Since you are on track to have a lot of money in tax-deferred accounts with RMDs, there's a pretty good chance that your regular tax rate on any extra RMDs on tIRAs will be higher than then 15% you'd save on the taxable accounts now.

If there's ever a need to withdraw more than the RMDs, having a big chunk in Roth IRAs in retirement might also aid you in allocating withdrawals to keep some of your RMDs in a lower bracket.

If you retire early, before RMD age and social security age, you might be able to withdraw the taxable funds with no tax. Or --depending on your tax bracket in early retirement -- roll some of the tax-deferred funds to Roth IRAs ... which would further reduce your RMDs when they do kick in.

Yet another factor to consider is that you can withdraw the contributions to Roth IRAs at any time without tax or penalty. (Not so with tax-deferred accounts.)

So in addition to the potential tax advantages in retirement, the Roths can serve as a secondary source of emergency funds in case you suffer a very expensive emergency before retirement -- such as a job loss or major cut in pay, or horrible accident or illness. (Bear in mind that it would still be better to withdraw money from the taxable accounts first. It needs to be awfully dire to make it worth giving up the life-long tax advantage of the Roths.)

The funds you already have in taxable are not all that bad anyway. I suspect the advantages of having the Roths will far outweigh the small difference -- if any -- in extra earnings in index funds versus those funds. Just invest your spare money in index funds in the future.

One other factor to consider. Since you are able to max two tax-deferred retirement accounts PLUS two Roth IRAs, there may be some time in the future when "backdoor" Roths might be feasible. In that case, NOT having any money in tIRAs is another advantage, because the amount you can convert is pro-rated between your non-deductible and tax-deferred IRA funds.

Congratulations on doing so well.

jimb
Topic Author
Enganerd
Posts: 239
Joined: Wed Apr 15, 2015 8:22 pm

Re: Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by Enganerd »

Thanks for the response and encouragement jimb! Yes we are fortunate. I ended up at this site through FIRE blogs and forums so I probably over emphasized the living on less portion of the personal finance equation when I might have been better off thinking about increasing human capital. But unless we make some career changes we will not see drastic increases in gross income from our w2 salaries (maybe we jump to 175k in today's dollars but could easily move backwards after adding a little one if the mrs. would like to stay home more). And when we have kids and move on from our starter house our annual expenses are bound to increase so our savings rate will take a hit but I plan on keeping our finances to where we can max out our deferred 401k type allowances and contribute to a roth. I'll have to stop investing into my after tax account but that would be fine.

I understand your recommendation on the roth vs traditional. That is why I have always invested in them despite thinking I might retire early so in that case it could likely make sense to save on my assumed to be higher tax rate in the present. However, looking back I kind of wish I used earlier opportunities to unload some of these funds I do not particularly care to own without paying capital gains. I was lucky to inherit some money as a child and my parents went through edward jones and set up the account for me. By far the worst part of the funds (the 5.75% front load) has already done it's damage. Now I just need to decide whether I want to sell out and move into index funds. My understanding, not making assumptions about comparative performance, is that the funds will obviously have higher fees and that because they are active there is probably more turnover and therefore tax drag. I don't really have a feel for how much that will cost me in the long run, which of course depends on my career and retirement date. So I have considered both leaving them and also selling them out paying the taxes and starting over with index funds. Just the other day reading this forum I realized I had the opportunity to sell some off each year without paying capital gains.

But if I do stick with my government job until pension eligibility (age 52 so still considered early just not extremely) I would undoubtedly be better off with more roth $ than deferred. But if I retire early I imagine it would have been better to save on taxes these days. Also because of my frugal saving habits if I stay employed because of the lure of the pension the math of saving so much looks foolish. I will be used to a lifestyle that my pension alone could afford and have portfolio more than large enough to provide more than the pension it self (assuming 4% SWR and 5% real returns going forward). A great problem to have for sure but probably would rather spread the spending out more evenly throughout the entire life. But right now the savers satisfaction is high and the higher my portfolio gets the more opportunities and freedom I feel like I have. So I keep saving away :beer
libralibra
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Re: Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by libralibra »

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Last edited by libralibra on Wed May 29, 2019 11:11 pm, edited 1 time in total.
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FiveK
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Re: Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by FiveK »

Enganerd wrote: Sat Jul 21, 2018 8:05 am That gives a taxable income of: 150-37-6.9-5.25-24-11= 65.85K
And a tIRA MAGI of 150-37-6.9-5.25 = 100.85K, just $150 below the start of the tIRA deductibility phaseout.

If you have and want to use a sharp pencil, it's probably worthwhile (i.e., would save 27% federal tax) to use a few thousand dollars of tIRA contributions to offset the same amount of LTCG. The more LTCG you take, the less tIRA contribution you can deduct. Using the personal finance toolbox spreadsheet (and some guesswork) I got ~$3600 of each.

You could use your own numbers in that tool for "what if...?" calculations.
Topic Author
Enganerd
Posts: 239
Joined: Wed Apr 15, 2015 8:22 pm

Re: Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by Enganerd »

libralibra wrote: Sat Jul 21, 2018 12:27 pm Your MAGI is too high to fully deduct a TIRA so your idea won't work.
Aw, that sounds familiar. I think that was why I figured it looked like we should just do the Roth. Let me make sure I have this right. Using the ball park numbers from the OP. Our MAGI would be 66.85k+24k(std ded.)+11k(IRA ded.)=100.85k. That appears to be just the very limit a full deduction or not.
libralibra wrote: Sat Jul 21, 2018 12:27 pm btw, if it had worked, you could sell more than 11k - you would want 11k gains, so you could sell ~25k given your basis - and the savings would have been 11k*.15
That's right! I was totally thinking of taking out tax deferred dollars but I could sell up to 11k in gains! Way more effective at clearing out those funds! It might be worth it even if say the last little bit of our IRA contribution is only partial, I will have to dig deeper.
Topic Author
Enganerd
Posts: 239
Joined: Wed Apr 15, 2015 8:22 pm

Re: Oops, for 2018 I think we should have funded tIRA not Roth. Please review relates to capital gains.

Post by Enganerd »

FiveK wrote: Sat Jul 21, 2018 12:44 pm
Enganerd wrote: Sat Jul 21, 2018 8:05 am That gives a taxable income of: 150-37-6.9-5.25-24-11= 65.85K
And a tIRA MAGI of 150-37-6.9-5.25 = 100.85K, just $150 below the start of the tIRA deductibility phaseout.

If you have and want to use a sharp pencil, it's probably worthwhile (i.e., would save 27% federal tax) to use a few thousand dollars of tIRA contributions to offset the same amount of LTCG. The more LTCG you take, the less tIRA contribution you can deduct. Using the personal finance toolbox spreadsheet (and some guesswork) I got ~$3600 of each.

You could use your own numbers in that tool for "what if...?" calculations.
Thanks for the link to the toolbox, exactly what I need to dig deeper
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