You are not my accountant, I am not your client, blah, blah, blah. etc. etc.
I’m doing my taxes and trying to decide if opening an IRA to reduce my taxes is worth it. Here’s some background:
60 yrs old
Will retire in the next couple of years
Income in low 6 figures (but low enough to qualify for an IRA contribution)
Already have significant money in retirement accounts.
Have the money to contribute to an IRA this year.
Marginal tax rate: 25%
I’m trying to figure out if this is worth it. Here’s how I understand the situation, but please correct me if I’m wrong. I contribute after-tax money to the IRA - say $6500. This gives me a deduction on my tax form of $6500 off of my AGI. This will save me, at 25% tax rate, $1625 on my Federal taxes.
When I go to withdraw the money, however, the full amount I take out will be taxed as ordinary income. During the time it is in the IRA, however, it grows tax free.
Do I have all of this right?
Does this sound like a smart thing to do?
What would you do in my situation?
Are there any factors I’m not considering?
Have you considered asking an actual, real live, reputable, accountable accountant instead of an Internet message board with dubiously qualified dudes?
This is the Achilles heel of your plan. If you were 30, it would probably make sense, but at 60? Do you want to wait 20-30 years until it appreciates? Seriously, do you really think the recent bull market will continue indefinitely?
If you invest it in a Roth IRA, you won’t get the tax benefit now, but when you withdraw, it’s all tax free, including the interest gained. It is by far the best retirement investment.
Actually your withdrawal counts as income, just stash money in it for a few years and let it sit til you’re not drawing anything but social security and you can supplement your income with periodic withdrawals from your retirement accounts at a much lower tax rate than you would pay now. Shoot, you might end up working longer than you expect, too, seen it happen to the best of planners.
Remember you don’t just get to compound gains tax free, you also shift your tax liability from now until after retirement. At a current 6 figure income, I don’t see how you lose unless you win the lottery or something - I expect that your tax rate after retirement is going to be lower than your current rate barring a huge pension, so even if you keep it in a money market account and make <1% a year you should still come out way ahead. Younger people worry that hey, maybe the government greatly increases tax brackets by the time I get around to retiring, but as close as you are that can’t and shouldn’t be a huge concern.
Speaking as a finance professional who has set up hundreds of IRA - both types - for people of all ages, here’s my advice:
Consult your accountant.
It is possible that one of the two types of IRA could be suitable for you as the tax advantages could be attractive. But everyone’s tax and financial positions are individual and unique and the best way to determine what moves are best for you is to consult a professional.
Thanks for the reply and I understand what you’re saying, but there’s something not quite right about your analysis. Your idea about having a lower tax rate in retirement is correct.
The money I would put in an IRA is money that has already been taxed. That money is mine right now, and no taxes are owed on it, unless I produce some gain with that money, and then the gain is taxable.
By putting money into an IRA, I’m converting money that has already been taxed into taxable money. When I withdraw money from an IRA, any money withdrawn is treated as ordinary income. So I’ll end getting taxed twice on this money.
First of all, you really should talk to an accountant. That is going to be by far your best advice.
The difference between a Roth and a traditional IRA is not one of double taxation but a matter of when the taxes are paid. With a Roth, you pay the taxes NOW and all of your gains and later withdrawals are tax-free. With a traditional IRA, you do not pay taxes now in exchange for any withdrawals being treated as ordinary income at the time you take the distribution.
To a simplest approximation, you pay 25% in marginal taxes now. If when you retire, you will be in the 15% bracket, it makes sense to put it into a traditional IRA because that income will only be taxed at 15% when you withdraw it. If, for some reason, you expect to be in the 28% or higher bracket upon retirement then a Roth makes sense so that you can pay taxes now in exchange for not paying higher taxes later.
Now there are other subtleties here. You have to start withdrawing from a traditional IRA at age 70.5 but there is no requirement for a Roth. There are some other subtleties relating to how the two types may be inherited if you’re thinking about your estate now. This is where an accountant would help.
I think this is going to be a key factor for the OP. There just won’t be time to really amass much interest before the IRA RMD starts to kick in and then the RMD will eat up the interest. The first year RMD (for most people) is over 3.6% and it grows each year.
It has to be viewed mainly as deferring taxes only on the income, rather than on income and interest, and whether that makes sense. I.e., what is the tax bracket going to be down the line?
Yes, you and the others are right. I wasn’t thinking about it clearly. I was thinking about taking money out of an existing money market account to open the IRA, thinking that this was money I had already paid taxes on. For tax purposes, however, this money would be considered “income that I had earned this year”. So that would prevent me from paying taxes on that money this year. So it wouldn’t actually be converting “taxed” money into “untaxed” money.
If you put that IRA money away post-tax - i.e. you’ve paid income tax on it - then when you withdraw it, you do NOT pay taxes on the original contribution.
Simplistic example: You put aside 6,500 now, post-tax. It grows to 10,000. You withdraw it all. You pay taxes only on the 3,500.
Now if you take money that you’ve earned, and designate it as being a pretax contribution, then your income is reduced. If you are earning 100,000, that 6,500 means your taxable income is 93,500 - so that 6,500 is NOT already taxes.
I mean, yeah, your employer took out taxes, but by making a pre-tax contribution it means you’d basically get a refund on the tax on that 6,500 now.
In all honesty, if you’re going to save that 6,500 now anyway, you have nothing to lose by putting it in some kind of IRA .I’d personally lean toward a Roth - as then the growth is never taxable. So you’d pay the taxes on the 6,500 now, but NOT pay the taxes on the 3,500 growth when you take it out (assuming the above hypothetical).
At age 60, you can also access that money right away if you need it, penalty-free.
I’m 60, retired, working occasionally as a temp. In the last 2 years, I’ve dumped the max amount into an IRA each year specifically to reduce my taxes. I have enough savings readily available that I shouldn’t have to touch that money for a few years, at which point I probably won’t be working any longer, so it’ll be taxed at a lower rate. Plus it’s earning a teensy percentage more than a straight savings account. It works for me.
Bear in mind, I’m an engineer, not a financial expert, but I discussed this with the guy who’s managing my retirement annuity and his head didn’t explode, so I’m thinking it’ll be OK.