Roth-IRA MAGI Limit Question and Strategy

[Guest fsutaylor31]

My questions:

- Does MAGI account for 401K money before its taken out? Or is MAGI straight pay without 401K taken into account?

- Are there better investment strategies for people who will make > 160K married filing jointly?

Help is appreciated! Thanks.

Brian

[John G]

It sounds like you expect to be qualified to start a Roth and contribute for two additional years. You may not be able to qualify in subsequent years, but that initial Roth continues to compound for many years. Three years at the max is 9k, but you would hope that those funds would double about every 7 years or grow to about $512k in about 42 years. Double that number if you both contribute to Roths for the next three years. When you no longer qualify for contributions, you still have a great retirement investment vehicle started. You don't "switch" investments. Rather you just start a new mechanism, depending upon your circumstances. The Roth can continue to work for you. I would not avoid a Roth just because you have a new choice in three years.

Are there better investment strategies? Not sure about better, but there are many ways to invest for the future. If you own a business, you may be able to set up a pension/profit sharing account that can set aside about 25%. If you work in a corporation, you probably have a 401k or thrift plan that may involve a match. School teachers (probably not with these salaries!) can usually contribute to a 403B. Each method has different qualifications, maximum contributions, possible matching contributions, subsequent taxation, etc.

It sounds like you do not have an accountant. If not, you should consider finding one and getting some tax advice on retirement/investing and general taxes. Don't wait for the next filing date when everyone is busy. Start looking around now and asking other professionals who they use. You are likely to spend a few hundred dollars, but often the advice you will get can be worth many thousands. [and I am not an accountant!] You can also find a lot of books at any good library on retirement planning or investing.

Let me put in a good word for "standard investing". That old fashion buy and hold strategy. When you buy and investment and hold it for more than 1 year, you get very favorable tax treatment.... lower long term capital gains taxation. Many of the retirement tax shelters treat distributions as ordinary income (not Roths) which means that taxable investing for long term capital gains. Investing in a retirement account that will eventually be taxed as ordinary income may be less attractive then investing in a taxable account and paying LTCG.

The keys to building substantial assets include: (1) managing your expenses so that you can set aside a substantial sum each year, (2) educate yourself about your options, (3) find one or more suitable mechanisms (Roth, IRA, 403b, 401k, standard investing, pension/profit sharing, etc.) and (4) sticking to the plan.

[dh003i]

All of the money that you contribute to a 401K or 403B is deducted from your AGI. Thus, you may be able to help yourself meet the RothIRA limit by contributing the max to these plans. Between you and your wife each contributing 13k to your 401K's or 403B's, that's be a 26K reduction in your combined AGI.

It is true that a 401K or 403B may end up being unfavorable compared to investing outside of a retirement plans and being taxed at the lower capital gains rates, especially when you consider that it is very difficult to imagine income taxes not increasing in the future.

However, one trump factor in these plans is employer matching: if your employer matches your contributions up to a certain point, you have to at least contribute enough to a 401K or 403B to max out those matching contributions. That's free money. Typically, you'll get an automatic 25% or 50% return on your investment; some employers even match 1:1, so that's a 100% return on your investment.

Alternatively, some employers contribute to your 401K or 403B no matter what you do. My current employer automatically contributes a dollar amount equivalent to 6.5% of my salary to my 403B, whether I contribute anything or not.

Also note that the contribution limits for RothIRA's will be increased to $4,000/year for 2005, 2006, and 2007. In 2008 and beyond, they go up to $5,000/year, with increases in $500 increments, adjusting for the CPI. So, over 3 years, you would contribute $12,000 to a RothIRA; if both you and your wife contribute to your own separate Roth's, that would be $24,000.

You may greatly benefit from the Lifetime Savings Account and the Retirement Savings Accounts that are currently being considered in legislation, if they pass; you can contact your Representative about the matter.

[Guest fsutaylor31]

John, thanks for the strategy info! It helps a lot.

dh003i, thanks for the news on the AGI question. Is there any reference you could point me to on the factors that are taken out before (such as 401K) that would not factor into the AGI total?

You guys have been extremely helpful. That is greats news about the MAGI not including 401K contributions, that will most likely enable us to keep going with the ROTH much longer than I anticipated.

Great news, I think I am about ready to start my ROTH investment ... I am going to post one other question, but in another thread!

Brian

[dh003i]

You can look on the IRS' website or just Google for it. To get MAGI, you start out with your AGI, and then add back various things (unfortunately).