ROTH IRA for spouse over add'l 401k contributions

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Kittle2020
Posts: 27
Joined: Tue Jul 14, 2009 2:54 pm
Location: Chicago

ROTH IRA for spouse over add'l 401k contributions

Post by Kittle2020 » Wed Aug 05, 2009 10:19 am

Just would like your thoughts on this theoretical situation. I understand the importance of first placing money in a 401k up to the company match, then maxing out a Roth IRA and if there is any remaining, max out the 401k.

If a family that has one income has $20,000 to invest, they would put $x in the 401k up to the company match (lets say that is $10,000). They would then put $5,000 in a ROTH IRA for one spouse. I would assume they should put the remaining $5,000 in a ROTH IRA for the other spouse instead of contribuiting it to the 401k.

Is that correct thinking?

Chuck
Posts: 2053
Joined: Thu May 21, 2009 12:19 pm

Post by Chuck » Wed Aug 05, 2009 11:17 am

In my case, because of a combined 30% tax bracket, my second choice after the 401k would be to make a $5000 deductible contribution to my wife's traditional IRA. (An unemployed spouse can make deductible IRA contributions, up to the income limit of the working spouse.) Next, would be the rest of my 401k, then finally my (working spouse) Roth IRA (just because my 401k makes me ineligible to make deductible IRA contributions).

This is, in fact, what my family does. And we max it to the max.

Roth is always my LAST choice because I don't expect to be paying 30% tax when I retire. Your situation may be different, and may favor the Roth. (Well, I guess I should say taxable is my last choice.)

sdrone
Posts: 108
Joined: Wed Jun 10, 2009 11:17 pm

Post by sdrone » Wed Aug 05, 2009 1:36 pm

Wait, what?
Chuck wrote:...An unemployed spouse can make deductible IRA contributions, up to the income limit of the working spouse....
I didn't know this. Does it matter how you're filing - jointly or separately? A stay at home mom can really make deductible IRA contributions?

mikep
Posts: 3694
Joined: Wed Apr 22, 2009 9:27 pm

Post by mikep » Wed Aug 05, 2009 2:33 pm

sdrone wrote:Wait, what?
Chuck wrote:...An unemployed spouse can make deductible IRA contributions, up to the income limit of the working spouse....
I didn't know this. Does it matter how you're filing - jointly or separately? A stay at home mom can really make deductible IRA contributions?
The details are in IRS pub 590. It looks as if a SAHM can make a traditional deductible IRA contribution subject to the same income limits as Roth IRA eligibility.. something like 150K but don't rely on me look at the pub.

I wish I realized this earlier. We can use HSA $5950, 401k 16,500, and spouse TIRA 5000 to chop $27,450 off my gross income. Wow!

I already contributed 3000 this year to my wife's Roth.. can I fix this for this year or wait till next year?

Chuck
Posts: 2053
Joined: Thu May 21, 2009 12:19 pm

Post by Chuck » Wed Aug 05, 2009 2:34 pm

You have to file jointly. It's all in Pub 590:

http://www.irs.gov/publications/p590/ch ... nk10006120

Chuck
Posts: 2053
Joined: Thu May 21, 2009 12:19 pm

Post by Chuck » Wed Aug 05, 2009 3:02 pm

mikep wrote:I already contributed 3000 this year to my wife's Roth.. can I fix this for this year or wait till next year?
You can probably recharacterize it. Talk to your custodian. You have until October 15 (I think) to recharacterize last year's contribution, too.

Kittle2020
Posts: 27
Joined: Tue Jul 14, 2009 2:54 pm
Location: Chicago

Post by Kittle2020 » Thu Aug 06, 2009 10:49 am

Chuck wrote: Roth is always my LAST choice because I don't expect to be paying 30% tax when I retire. Your situation may be different, and may favor the Roth. (Well, I guess I should say taxable is my last choice.)
So, I guess the answer to my question is that it depends on your current tax rate vs. your expected future tax rate. That makes sense.

However, from my reading it seems as a general rule that if you have ten plus years before retirement, your investment in a Roth IRA should grow to such a degree that you are entitled to a larger tax benefit upon withdrawal relative to the early tax benefit of a traditional IRA. Additionally, I suppose expense ratios should factor in (Vanguard IRAs vs. Company 401k) to the analysis.

Lastly, to answer my own original question, of course the easy fix would be to be able to save $26,500 so one doesn't have to choose b/t the 2nd Roth and the 401k.

Chuck
Posts: 2053
Joined: Thu May 21, 2009 12:19 pm

Post by Chuck » Thu Aug 06, 2009 12:47 pm

Traditional and Roth are both tax-deferred, so they compound exactly the same. So if you pay the same tax rate on contributions and withdrawals, the outcome is completely 100% identical.

The way I see it, the first $16,700 (plus exemptions) I withdraw from my traditional IRA will be tax free (in the 0% tax bracket). So let's say I use $30,000/year during retirement (should be easy with no mortgage payment). I pay $1155 tax (including exemptions). That's an effective tax rate of 3.9%. I deducted 25% when I contributed (because it was all marginal). That's an unequivocal win for the traditional IRA.

Even if you are in a higher tax bracket in retirement, the Traditional still wins. Let's say we draw $250,000/yr from our Traditional IRA. That's squarely in the 33% bracket (all my calculations are married filing jointly, forgot to mention). Tax on that is $56,500, an effective 22.6%. That's still less than the 25% I deducted on contribution.

Even so, we do have the Roth (because my 401k makes me ineligible for deductible IRA contributions). So if I was really drawing $250K, I'd take the top portion of my income (the 33% part) from the Roth. That's where your tax diversification comes in. I might take $215K from the traditional, and $35K from the Roth, saving the 33% portion with money I paid 25% on. That would be an effective 21.6% rate (including the tax on the Roth contribution). Not much different, but saves almost $2500 during retirement.

So the proportion of Roth vs traditional is kind of guessing, but since my family is maxing out tax deferred plans every year, we can only really choose where $5000 goes, and we choose traditional.

Post Reply