Another IRA situation

[texastek76]

I have been thinking about this issue for some time now. My wife is a stay-at-home mother and I have been contributing the max to a Roth IRA for her for five years. This past year we exceeded the income limit and I had to recharacterize her 2007 contributions to a traditional IRA.

I was surprised to find out (because I had done no research on traditional IRAs before) when I did my taxes that we also made too much to deduct her contribution. That means that I funded her traditional IRA in 2007 (and going forward) with taxed dollars. The whole selling point of a traditional IRA is that you contribute pre-tax dollars and those funds grow oevr time and you get taxed on withdrawal. If you contribute taxed dollars and get taxed in the end you are getting taxed twice, correct?

If this is all true it seems to me like this is a big waste of money. I would be smarter to contribute those same funds to a simple brokerage account. The dollars would be taxed of course but in the end I would only pay capital gains tax and not the higher income tax (depending on what bracket you are in).

Can anyone shoot holes in any of this?

[jIM_Ohio]

You only pay taxes on the gains, I believe, in a traditional IRA. Check me on this (look at IRS pub 590).

I would consider creating a more mid term or long term plan for the retirement monies. Use 401k more now, use taxable accounts now, and possibly use traditional IRA (non deductable) if it makes sense as part of a 10-15 year strategy to lower taxes paid over your life. Or maybe you want to use a dividend strategy to outpace inflation. Or maybe you have a college plan which needs funding.

Consider: You are in 25% bracket now, maybe 28% bracket. I guess this because you are not eligble for Roth, and the Roth cap is around 150k AGI.

Do you have a 401k? Would it make sense to increase 401k contributions 5k and forgo the IRA for your wife?

When you retire, have you considered
a) what age that might be? 59.5 is a key age.
b) how much you'll have (@age 59.5)
c) how much you'll need to withdraw each year?

If the current 401k is an IRA at age 59.5 (because you rolled it over), then you could convert the IRA to a Roth in increments, assuming

a) you have money available to pay taxes on the rollover
b) your income needs when retired are in 15% tax bracket (66k is top of 15% bracket right now)
c) you have other investments which can be used for income while converting 401k to Roth.

So you need a multi pronged plan now to give you room to complete mid term objective (turn Trad IRAs into Roths and turn 401k into Roths). If you skipped paying 25% taxes on 401k contributions, then converted to a Roth at 15% tax rate, you saved yourself considerable tax money.


My personal opinion is many people put money into 401ks and IRAs in hopes of accumulating enough money to retire on, but do not plan on withdraw techniques until 1-5 years prior to retirement. At that point some of the choices are locked in. It might take 10-20 years to convert a 401k to a Roth at 15% tax bracket level (because you could only convert up to 15% bracket level-66k- to do this).

If you are deep in 25%-28% or 33% tax brackets, my suggestion would be to convert 401k at next lowest bracket.

59.5 is a key age because you can withdraw from the IRAs without being required to do so. Even if you are not retired, you could withdraw from IRA to cap out current tax bracket and fund a taxable account, for example.

This could prevent the required distributions (which start at age 70.5) from pushing you into a higher tax bracket.


So my point is have a plan which goes beyond accumulating. This can help make the decision easier. Use 401k more, use taxable account more. Have a plan to take money out, based on retirement age, and the vehicle you use (401k, Roth, traditional, taxable) will fall into place.