Traditional or Roth? ACA implications

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Bfwolf
Posts: 2062
Joined: Thu Oct 14, 2010 11:19 am

Traditional or Roth? ACA implications

Post by Bfwolf »

Hey Boglehead Brain Trust,

I'm self employed and am deciding between traditional vs Roth solo 401k and IRA contributions for 2020. I can deduct all traditional contributions. There's $25,500 in contributions that could be traditional or could be Roth. The tax implications to my specific 2020 tax situation are shown in this table, broken down into $5,100 chunks. So the first row is no traditional contributions. The second row is $5,100 traditional, etc.

Image

I should point out that the Total 2020 tax owed column is how much I'd owe in addition to the estimated taxes I've already paid. It's not my total annual tax obligation. As you can see, I'm getting a refund no matter what. This reflects both federal and state taxes.

Alright, so the taxes I'm saving aren't huge with the traditional contributions. Cumulatively, I'm going to be in the ~13% range.

The comparison point to the tax rate when I'd withdraw the traditional $s is tricky to estimate. I'm 45. I have a $18K/year pension in nominal $s coming when I turn 65. I expect I'll get SS of around $30K a year in 2021 $s when I turn 70. I have roughly $700K in taxable account investments, $500K in Roth investments, and $500K in traditional IRA/401k investments. 75% stocks, 25% fixed income. I currently make about what I spend. Will I retire at 60 and have several years to draw down my traditional IRA/401k at low tax rates? It's possible but not assured. And since I already have a significant traditional IRA balance, it increases the risk that I'm withdrawing any new traditional IRA/401k contributions and their earnings after age 70.

So at first glance, the marginal tax benefit of making deductible contributions seems low enough that on the face of it, Roth might be a better option. The complicating factor here is the ACA. I have a silver Obamacare plan and am receiving almost $4K in subsidies in 2021 plus cost sharing reductions that result in an extremely low deductible and max OOP. In regard to the cost sharing reductions, I am typically a pretty low consumer of health care but you never know.

My concerns if I don't take a big deduction:

1) The impact to how much of my 2021 subsidy I'd have to pay back. I know the government waived advanced premium tax credit repayment for 2020, but I don't think the same is true for 2021? I'm not sure what the repayment caps are--I think they vary based on income?

2) My ability to claim the subsidy and cost sharing reductions in 2022. When filling out my 2022 ACA application, I could probably justify that this higher income was a one time thing and I plan on taking the deductions in 2022, but it does seem like saying I expect such dramatically lower income than I had the prior year puts me at higher risk for an audit. Though I don't know if that's just a phobia or whether it's a reasonable thing to be concerned about. And in any case, wouldn't I then find myself with the same decision a year from now--do I take the big IRA/401k deductions for tax year 2021 or not? I don't think I can keep claiming year after year I'm going to have low income every time I apply for the ACA and then finish with income that's ~$25,500 higher.

Thoughts on how I should proceed?
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FiveK
Posts: 11550
Joined: Sun Mar 16, 2014 2:43 pm

Re: Traditional or Roth? ACA implications

Post by FiveK »

Bfwolf wrote: Mon May 03, 2021 3:00 pm I'm self employed and am deciding between traditional vs Roth solo 401k and IRA contributions for 2020.
...
The complicating factor here is the ACA. I have a silver Obamacare plan and am receiving almost $4K in subsidies in 2021 plus cost sharing reductions that result in an extremely low deductible and max OOP. In regard to the cost sharing reductions, I am typically a pretty low consumer of health care but you never know.

My concerns if I don't take a big deduction:

1) The impact to how much of my 2021 subsidy I'd have to pay back. I know the government waived advanced premium tax credit repayment for 2020, but I don't think the same is true for 2021? I'm not sure what the repayment caps are--I think they vary based on income?
...
Thoughts on how I should proceed?
Are you asking about tax year 2020 or 2021?

If 2021, there was a recent update to the personal finance toolbox to do the iterative calculations when both Premium Tax Credits (PTC) and Self-Employed Health Insurance (SEHI) premiums are involved. That could be useful for you.

Even if you don't need those iterative calculations, that tool will include ACA effects in your marginal tax rate calculation, which addresses your complicating factor.
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