is this worth it?

[Guest quaspro]

My wife and I are a few thousand above a certain tax bracket. I figure if I can get another $2,000 in deductibles, we can get $500 more in tax refunds. We are eligible for either Roth or traditional IRA contributions. We haven't contributed to our 2003+2004 IRA accounts yet which I fully intend to soon with a maximum contributions in mind. All things being equal, I prefer Roth IRA contributions but I realize if I make $2,000 contributions to an deductible IRA traditional account, I can lower our tax bracket and get another $500 back from the IRS. Now I've done some rough calculations to see whether or not this is worthwhile for me or not and I like to get some opinions around here. If I'm correct, my choice really boils down to comparing A $2,000 investment in a Roth IRA account vs a $2,500 investment in a traditional IRA account (assuming that I plow the $500 savings into the same investment vehicle (non-IRA though). I found that if I'm assuming anything less than 20% tax bracket when I'm in retirement around 20 yrs from now, the traditional IRA account with the extra $500 will do better than the $2,000 Roth IRA account. Now can I also avoid all of this if I can rollover traditional IRA account to a Roth account in the future? and essentially take a $500 extra tax refund this tax season? Is that another feasible option for me to take?

Thanks for any response

[ElGuapo]

If I'm correct, my choice really boils down to comparing A $2,000 investment in a Roth IRA account vs a $2,500 investment in a traditional IRA account (assuming that I plow the $500 savings into the same investment vehicle (non-IRA though).  I found that if I'm assuming anything less than 20% tax bracket when I'm in retirement around 20 yrs from now, the traditional IRA account with the extra $500 will do better than the $2,000 Roth IRA account.

First, sounds like you're trying to decide mathematically which is better, Roth or traditional. Unfortunately, if it were that simple everyone would do the same thing.

Turns out that if your tax bracket remains the same and you had $2,000 of taxable income to invest, mathematically they're identical. You could put the whole $2,000 in a traditional, owe no tax, say your investment multiplies 10x to $20,000, then you pay 25% on withdrawal, what are you left with? ($15,000)

Now look at the Roth. You've got $2,000, but you have to pay 25% tax on it, so you pay now and put the remaining $1,500 in the account, it grows 10x to $15,000, then you withdraw tax free--what are you left with? ($15,000)

So basically, I'd forget all the math stuff because it won't help you make this decision. Instead focus on things like Do you need the deduction now? Do you expect your tax situation to change? Are you trying to maximize your contributions? How important is it to you to have penalty-free access to your contribution amounts? Your accountant or IRA custodian can help you talk through those decisions and make the right choice.

As for the last part of the question, that's called a conversion, not a rollover, and it won't get you any "extra" tax savings, because you'll pay tax on the amount you convert, so it's essentially the same decision you're making with the new money--pay now or pay later.

Hope this helps.

[david rigby]

One more question to ask: what do you (realistically) think that $1500 will be worth when you take it out? (Hint: Don't believe any of the hype. One possible answer is $1500.)

[Lame Duck]

Another question that may impact your decision to make a Roth IRA or traditional IRA contribution. Did you have a taxable windfall this year that moved you into a tax bracket higher than your normal one. If you will be in a lower tax bracket next year you might want to consider making the traditional IRA contribution and then converting it to a Roth IRA next year, when your taxes will be lower. however, in order to convert a traditional IRA to a Roth IRA, your adjusted gross income must not exceed $100,000 and you must file a joint tax return with your spouse.

In addition, you may also be able to make an IRA contribution on behalf of your spouse, which can increase the total amount of IRA contributions to $6,000. This can be divided in any manner you see fit, so long as the amount contributed on behalf of you or your spouse does not exceed a total of $3,000 in total. For example, you could contribute $2,000 to a traditional IRA and an additional $1,000 into a Roth IRA.

[Guest quaspro]

thanks for all of your replies.

Now that I think about what you people are saying, it is essentially not much diffence either way... Kind of silly of me to ever think the IRS would offer free money for one type contribution over another even if I do have choices. We are a few thousand about the $56,800 taxable income threshold and the excess gets taxed at 25% so I figured if I get to $56,800 level through traditional IRA deductions of $2,000, we can get an extra $500 in refunds since we are getting refunds this year. But the effective tax rates regardless of what we do is essentially around 14%. I've no idea what tax bracket we will be in the near future since I'm in quite a volatile business so I wish I could plan better. And thanks for clearing me up on the conversion part.

For now, I'm hope we do qualify for deductions since our MAGI is less than $150,000 and I do not participate in any company retirement plans even though my wife does. Based on pub 590, I believe we can take $2,000 deductions if I contribute to a traditional IRA on my account.

[John G]

There are additional factors to consider.

You might value having more funds in a Roth where there is no mandatory withdrawal requirements and there may be some advantages using a Roth as part of an inheritance.

I think another possibility is that you become significantly more successful in the future and your income climbs to higher tax brackets. A friend I knew 20 years ago on the east coast is amazed that he know faces this problem - he was successful, his wife was successful, there investments did well - and eventually he will face a mandatory payout that will keep his income above 120k for probably the rest of his life. His kids are not longer around, the mortgage is paid for... and the tax bite will be big.

I would suggest that both paths will work for you, and your crystal ball is just not accurate enough to predict which path is optimal. Make a decision, focus on how to best invest those funds and stick to your plan. Time is your allie in reaching your goals.

[WDIK]

Good points John G.

It's not necessarily a bad thing to end up in a higher tax bracket.

[John G]

Yep. Although sometimes it takes an attitude re-alignment to realize this.

[Guest quaspro]

thanks everyone for all your replies. John, that is a very good point on the mandatory withdrawal...didn't know that.