Tax shelters for graduate students??

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mudphudstud
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Tax shelters for graduate students??

Post by mudphudstud » Fri Aug 06, 2010 1:40 pm

Hi Bogleheads!

I'm 23 and recently started a full-time graduate program that includes full scholarship plus a modest living stipend (27k). Apparently I live more modestly than they expected, because I have been enjoying a significant surplus at the end of each pay period. Having extra money for the first time in my life, and realizing that I won't always be 23, I decided to enter the world of investing, and I was very fortunate in that the first financial professional I met with is a big proponent of the Boglehead style of investing (although I'm not sure he knows it :wink:) and put me on the right track. Since then, I've been doing a lot of research and reading on my own, and stumbled across this forum and wiki a couple of months ago. I'm a big fan.

The problem is, I'm having trouble finding any sort of tax shelter for my investments. I don't receive a W2 from my program, which I believe means that my income doesn't qualify for IRA contributions. Unfortunately, it doesn't mean that the income is exempt from income taxes (I have to pay estimated quarterly taxes). There is no 401(k) program available to graduate students here either. So my question is, is there any sort of tax shelter available for a graduate student who doesn't get a W2? I am a legal resident of Michigan and living/going to school in Illinois. Thanks in advance for the help!

[edited to remove personal portfolio information]
Last edited by mudphudstud on Thu Sep 02, 2010 1:10 pm, edited 1 time in total.

vesalius
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Post by vesalius » Fri Aug 06, 2010 2:50 pm

People who earn taxable income are eligible for an IRA or better yet a Roth IRA, especially if the "mud" in mudphudstud stands for M.D. as I remember it too. Many people do not get W2's, small business owners and people that work for cash for example.

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Opponent Process
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Post by Opponent Process » Fri Aug 06, 2010 3:23 pm

I was in the same position as a neuroscience graduate student, receiving a stipend from the NIH. unfortunately, the income you earn in this particular case is not eligible for Roth contributions. I was able to contribute to a Roth as a grad student because I was married to someone with earned income. I would just contribute to your taxable accounts, maybe build an emergency fund.

as a side note, about 90% of biomedical science grad students/postdocs I know do not pay their estimated taxes on these stipends. not that they are necessarily trying to cheat the government, but since the income is not reported to the IRS, they feel that it is not taxable.
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livesoft
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Post by livesoft » Fri Aug 06, 2010 3:27 pm

If you pay income taxes on your stipend, then you are eligible for an IRA. Open a Roth. I still have the IRA I opened as a grad student.

vesalius
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Post by vesalius » Fri Aug 06, 2010 3:42 pm

Opponent Process wrote:I was in the same position as a neuroscience graduate student, receiving a stipend from the NIH. unfortunately, the income you earn in this particular case is not eligible for Roth contributions. I was able to contribute to a Roth as a grad student because I was married to someone with earned income. I would just contribute to your taxable accounts, maybe build an emergency fund.

Really?? I do not see how this is the case. Being a former mudphud I opened and contributed to a IRA, before roth was available. Maybe things have changed or my stipend was different than his, it sure was smaller.

as a side note, about 90% of biomedical science grad students/postdocs I know do not pay their estimated taxes on these stipends. not that they are necessarily trying to cheat the government, but since the income is not reported to the IRS, they feel that it is not taxable.

I can certainly understand that those that do not report the stipend and pay taxes on will not be able contribute to any sort of IRA.

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Opponent Process
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Post by Opponent Process » Fri Aug 06, 2010 3:55 pm

you need "earned income" to contribute to an IRA. according to the IRS:

1. Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment.

2. Earned income does not include:

• Scholarships or fellowship grants, except for those reported on Form W2 and paid to you for teaching or other services.

most fellowships are not "in exchange for services" and they are very clear about this (lest they should have to give you many other benefits as an employee). teaching stipends are OK, and if you were paid from a research grant you'd be OK. but you'd probably be seeing a taxable check in these circumstances.

like I hinted at before, the rules are a little muddy, and I know of only one "bust" where the IRS came into a grad department and investigated the students. you could always plead with the IRS that you were unclear about your Roth eligibility. or got some bad information on a message board. :D
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vesalius
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Post by vesalius » Fri Aug 06, 2010 4:11 pm

Opponent Process wrote:you need "earned income" to contribute to an IRA. according to the IRS:

1. Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment.

2. Earned income does not include:

• Scholarships or fellowship grants, except for those reported on Form W2 and paid to you for teaching or other services.

most fellowships are not "in exchange for services" and they are very clear about this (lest they should have to give you many other benefits as an employee). teaching stipends are OK, and if you were paid from a research grant you'd be OK. but you'd probably be seeing a taxable check in these circumstances.

like I hinted at before, the rules are a little muddy, and I know of only one "bust" where the IRS came into a grad department and investigated the students. you could always plead with the IRS that you were unclear about your Roth eligibility. or got some bad information on a message board. :D
Thanks I can only assume I fell under the "in exchange for services" variety of stipend with a W2 because I am certain I paid taxes and I have not ever paid estimated quarterly taxes. As result of being conscientious, it sounds like mudphudstud is going to get the shaft from the IRS. I guess he can chalk it up to practice for what will come after graduation. :?

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baw703916
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Post by baw703916 » Fri Aug 06, 2010 8:56 pm

livesoft wrote:If you pay income taxes on your stipend, then you are eligible for an IRA. Open a Roth. I still have the IRA I opened as a grad student.
The IRS disallowed my IRA deduction when I was a postdoc because the stipend was listed as an "award" and therefore wasn't "earned income" (I guess, technically I didn't have to do anything to collect it? :roll: )

It depends on the exact details of how things are defined in terms of what your stipend is counted as.

Brad
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mudphudstud
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Post by mudphudstud » Sat Aug 07, 2010 12:08 am

Opponent Process wrote:you need "earned income" to contribute to an IRA. according to the IRS:

1. Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment.

2. Earned income does not include:

• Scholarships or fellowship grants, except for those reported on Form W2 and paid to you for teaching or other services.

most fellowships are not "in exchange for services" and they are very clear about this (lest they should have to give you many other benefits as an employee). teaching stipends are OK, and if you were paid from a research grant you'd be OK. but you'd probably be seeing a taxable check in these circumstances.
That's what I found too, and the reason I closed down my Roth IRA less than a month after excitedly (and prematurely, apparently) opening it at Vanguard. Fortunately the value hadn't increased much yet, so the penalty will be minimal, but the lack of anywhere sheltered to put my money remains frustrating. The place I found the eligibility technicality was on IRS publication 590 (2009) IRA FAQs under the section titled "What Is Compensation?" (Sorry, as a new member I'm not allowed to post links yet...)
vesalius wrote:As result of being conscientious, it sounds like mudphudstud is going to get the shaft from the IRS.
Sounds like it to me too :(

Anyone know of any tax shelter at all that could be utilized in this type of situation? Thanks so much again for all of your help!

MrMiyagi
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Post by MrMiyagi » Sat Aug 07, 2010 8:03 am

The above people are correct. You can't contribute to a IRA - traditional or Roth because it's considered a "stipend" not a "wage."

Since you don't have any student loans, I would save the money in one of those online high-interest savings accounts since as ING, HSBC until you need it. When you start residency, then you'll have enough liquid assets (cash) to contribute fully to a Roth IRA and/or 403b pre-tax deductions, and live off your savings. Doesn't hurt to have an emergency fund too (those textbooks, equipment, and tests are expensive!)

Also since you're MD/PhD, I'm assuming you'll be at your program for at least 7 years. I would consider buying a home (location-dependent). A lot of my former classmates ended up staying at our home institution for residency too so obviously their home investment paid off well.

Personally, I'm starting to think it's NOT worth it for a MD to save. Your income now, and as a resident, will be a pittance compared to what you will earn as an attending. At that point, your income will be significantly higher and you'll have plenty of time to contribute fully to pre-tax tax sheltered retirement contributions. I've personally scaled back considerably on my retirement contributions (i'm a resident), to just 5% pre-tax and the 5000/yr Roth IRA.

I know this is contrary to "traditional advice" but because of the way income works for physicians (namely you are forced to live like a college student all through medical school and residency), it's better to maximize your tax-advantaged shelters when you become an attending.

Good luck in school.

retiredjg
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Post by retiredjg » Sat Aug 07, 2010 8:55 am

I would not worry about having the tax shelter. There will be plenty of time for that later. And you are unlikely to be in a high enough bracket for it to matter now.

I know there is always a push to get money sheltered. But there are plenty of good uses for taxable accounts too. For example, when you do get into something that has a 401 (or whatever) you can use the taxable money in a couple of ways.

1) You can "transfer" money from taxable to sheltered by living off the taxable money and having a larger percentage of your salary sent to the 401.
2) You can use the taxable space for low cost tax-efficient funds that are not available or too expensive in your 401.

Not to worry about no tax shelters now. What matters is that you are saving money. The rest will all work out in the end.

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market timer
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Post by market timer » Sat Aug 07, 2010 9:27 am

MD/PhD programs usually have two years of MD, 3-4 years of PhD, then 1-2 of MD, right? While I think the stipend for the MD years is rightfully considered an award, perhaps you can claim the stipend as earned income in years when you serve as a research or teaching assistant. I'd look into this. The tax-free space will be valuable later when you are in a higher tax bracket. On the bright side, at least you'll have no med school debt.

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Opponent Process
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Post by Opponent Process » Sat Aug 07, 2010 9:55 am

market timer wrote:While I think the stipend for the MD years is rightfully considered an award, perhaps you can claim the stipend as earned income in years when you serve as a research or teaching assistant. I'd look into this.
the whole thing is an award. it's a training program, not earned income in exchange for services. students are admitted as MD/PhD candidates.

in other fields, and in "poorer" science departments, students have to hustle for some means of living while obtaining advanced degrees (e.g., I'll teach this class for $5000-earned income). it's a struggle for sure. in contrast, for the most part in the biomedical sciences, we receive NIH/taxpayer funding for training fellowships.
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JW-Retired
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Post by JW-Retired » Sat Aug 07, 2010 11:06 am

I don't receive a W2 from my program, which I believe means that my income doesn't qualify for IRA contributions. Unfortunately, it doesn't mean that the income is exempt from income taxes (I have to pay estimated quarterly taxes).
Per IRS Pub 970 you are correct you owe taxes. Scholarship and Fellowship Payments that are used for Room/Board/travel are taxable, payments that go toward tuition/fees/books/supplies are not.

Pub 970 doesn't say anything about using this as IRA eligible income but I think it is absolutely OK to do so. I dry ran your situation through my tax software (H&R Block TaxCut) with your only income being $15K of taxable scholarship, and also put in a $5K TIRA deduction. Taxable scholarships/fellowships are an income line item in the software menus. Error check said the IRA was fine with this type of income. The program would not accept the IRA deduction if it was not legitimate. On the 1040 the $15K shows up on line 7 "wages, etc", and the TIRA deduction shows on line 32. You end up owing $66 tax.

I would do a Roth IRA and just be sure to save the Form 8606 that results.
JW

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baw703916
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Post by baw703916 » Sat Aug 07, 2010 12:44 pm

JW Nearly Retired wrote:
I don't receive a W2 from my program, which I believe means that my income doesn't qualify for IRA contributions. Unfortunately, it doesn't mean that the income is exempt from income taxes (I have to pay estimated quarterly taxes).
Per IRS Pub 970 you are correct you owe taxes. Scholarship and Fellowship Payments that are used for Room/Board/travel are taxable, payments that go toward tuition/fees/books/supplies are not.

Pub 970 doesn't say anything about using this as IRA eligible income but I think it is absolutely OK to do so. I dry ran your situation through my tax software (H&R Block TaxCut) with your only income being $15K of taxable scholarship, and also put in a $5K TIRA deduction. Taxable scholarships/fellowships are an income line item in the software menus. Error check said the IRA was fine with this type of income. The program would not accept the IRA deduction if it was not legitimate. On the 1040 the $15K shows up on line 7 "wages, etc", and the TIRA deduction shows on line 32. You end up owing $66 tax.

I would do a Roth IRA and just be sure to save the Form 8606 that results.
JW
If it really is earned income, wouldn't you have to pay social security (or self-employment tax)? That's the whole reason for this odd categorization. The University would have to pay half of the social security+medicare, or raise the stipend if the student were expected to pay 15.3% off the top.

I'm extremely dubious about TaxCut's interpretation (and I even use the program myself).

Brad
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Post by JW-Retired » Sat Aug 07, 2010 5:48 pm

Brad wrote: I'm extremely dubious about TaxCut's interpretation (and I even use the program myself).
I would put a lot more stock in TaxCut then in my own idea of what a logical interpretation might be.
JW

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Post by Opponent Process » Sat Aug 07, 2010 5:56 pm

I would put a lot more stock in the IRS, which is clear on the matter.
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Post by JW-Retired » Sat Aug 07, 2010 6:06 pm

Opponent Process wrote:I would put a lot more stock in the IRS, which is clear on the matter.
If they are, it would be helpful to everybody if you would cite the IRS Publication reference.
JW

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Post by JW-Retired » Sat Aug 07, 2010 6:17 pm

Hmmm. I see Pub 590 says "Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2."

I stand corrected. TaxCut appears to have it wrong. Shoulda read the whole thread more carefully.
JW

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Opponent Process
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Post by Opponent Process » Sat Aug 07, 2010 6:30 pm

along with the taxability issue, it has confused pretty much every grad student and postdoc I've ever worked with, and we're talking about pretty smart cookies here. for example, I do know students on these fellowships who do not pay taxes yet do contribute to Roths. :shock:

it's heavily based on the honor system, as the fellowship income is not reported to the IRS.
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livesoft
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Post by livesoft » Sat Aug 07, 2010 6:50 pm

OK, here's a tax shelter for you: marriage.

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Post by Jacotus » Sat Aug 07, 2010 9:26 pm

Opponent Process wrote:along with the taxability issue, it has confused pretty much every grad student and postdoc I've ever worked with, and we're talking about pretty smart cookies here. for example, I do know students on these fellowships who do not pay taxes yet do contribute to Roths. :shock:

it's heavily based on the honor system, as the fellowship income is not reported to the IRS.
This is true, it is confusing. It took me a while to come to the conclusion, against my hope, that I could not contribute to a Roth on fellowship income. But once I accepted it, it became clear that the IRS is in fact quite clear on the matter: 1) your fellowship income is unearned taxable income (no W2), 2) you have to pay estimated quarterly taxes, and 3) it does not allow you to contribute to an IRA.

I have heard stories of people not paying their taxes at all, whether out of ignorance or simply trying to get away with it. I prefer to pay my fair share and also not run afoul of the law. Also, I am able to obtain a small amount of earned income (through TAing, for example) and can contribute a little bit to a Roth.

slick_dealer_05
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Post by slick_dealer_05 » Sat Aug 07, 2010 10:05 pm

Another tax shelter: Paid internship
You can contribute 100% of that income to IRA
When I interned as a graduate student, I maxed out my Roth IRA and contributed the maximum eligible amount (50%) to the 401k during my 3 month internship period.

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