Traditional vs Roth IRA, first time contributing

[JR]

Hello,

I am a new attending, 6 months into my first job. Married, filling jointly.

I contributed the max allowed to my new 403b and a non gov 457 accounts in the last 4 months of the year ($18K each, yes, my first 4 paychecks made my cry). My wife is currently not working and is not covered by a retirement account (though she still has $ in a retirement account from a recent employer).

Modified Adjusted Gross Income 2016: $110K

Earned income 2016: $109K

I understand contributing to an IRA will help diversify my retirement income options. I'm currently working on my 2016 taxes. The problem is I have no idea what would be the best for us since I have no prior experience with IRAs. Deductible traditional? Non deductible? Roth? TaxAct online says I can contribute $2170 and my wife $5,500 to a deductible IRA for the year 2016. It looks like we could also both contribute $5,500 to a Roth IRA instead.

We expect our MAGI to be around $250K in the next few years.

I would appreciate any help/information on how to best make this decision.

Thank you!

 

[jfoxcpacfp]

This is your last year in a bracket that low. While a deductible TIRA would save a few tax dollars, there will never be a better time to maximize your Roth space. I recommend you and your wife both contribute $5,500 to Roth IRAs. Continue with back-door Roths for 2017 and beyond if you can afford to fund them. At "only" $250k AGI, I still believe they are a good choice, especially if either of your work plans are sub-optimal.

[DMFA]

$5,500 each into two Roth IRAs. You can make the direct contribution for tax year 2016 until April tax day comes.

For tax year 2017, do the backdoor Roth: make a non-deducted (up to) $5,500 Traditional IRA contribution, then convert it to Roth a few days later. This can be done with a few clicks on Vanguard or Fidelity. You can even leave the trad acct open with $0 for p much the whole year (since it basically just functions as a conduit for the Roth).

[JR]

Thank you all very much for your help. Roth IRA it is then.

[DMFA]

You are filing jointly, right? Just bc direct Roth contributions aren't allowed for MFS.

[JR]

Yes, we are filling jointly this year for the first time. I just opened us Roth IRAs with Vanguard and I was exploring different investment options/reading other threads here. It seems that funds like VTSMX and VGTSX have a $3000 minimum. I certainly want to do at least 90% if not 100% stocks now and I will be very comfortable with that risk. Any suggestions on how to approach my initial investments knowing that both our Roths will be limited to $11K each until 2018?

[DMFA]

ETFs can fill your gaps if you don't have funds for a minimum mutual fund investment. Their ERs are also lower than the "investor-class" mutual funds. You might do will to use VTI and VXUS until you've got the $10,000 to buy VTSAX and VTIAX.

I wouldn't have any bonds to start this early. You don't need that security on that small amount to offset the likely larger gains you'd get from equities. If you do, I'd just use BND for prob no more than 10% until your portfolio is big enough to use VBTLX.

[artemis]

Since you say you're OK with a 100% stock allocation, for now I'd put all the money in each fund into VTSMX, since the $5,500 upper contribution limit won't allow you to open two different funds.  You can add VGTSX and a bond fund to each account for diversification a few years down the road.

[jjandjab]

Congrats on the new job. My input here is to make sure to read about the issues surrounding non-governmental 457 plans. They are a strange beast...

I have had one for 2 years now and I go back and forth about whether to keep contributing or not. My main issue is that despite your 18k contribution, it is not considered "your money" until you either leave your job or you retire. The assets remain part of the hospital/employer, and are subject to creditor risk. And if you do leave your job, you can't roll them into anything else and you have to take the payout and pay taxes on the distribtution (or leave it at the employer if they let you)

Now clearly bankruptcy isn't too common - but I did have this happen to me - the first hospital where I worked for 9 years closed suddenly. Thankfully I was a private contractor, but it does give me pause to contribute to a plan where the assets aren't "mine".

I am in the max tax bracket right now, so the tax benefit is too good to pass up, but it is a concern. I may do it for another year or two then just put the money in a taxable account to feel "safer"

[JR]

Thanks so much for the advice. I definitely share your concerns and did some reading prior to deciding to contribute to the 457 plan. I agree with you that while there is a potentially serious downside, the tax benefit seems good now. Today the 18K/year I contribute would be getting taxed at 25% and it'll be in the 33% bracket for 2017. Here is what my plan states:

 

"As long as you make an election prior to March 1 of the year following the year in which you retire or terminate employment, you may defer the payment of your account balance to a future date. You may also make a second election to defer payment of your account balance if you do so more than 30 days prior to your payment date. In no event, however, may you defer your payment beyond April 1 of the year following the year in which you reach age 701⁄2 or, if later, April 1 of the year following the year in which your employment terminates.

You must begin receiving distributions by April 1 of the year following the year of your retirement or termination, or by April 1 of the year following the year in which you reach age 70 1⁄2, whichever is later. Your account balance will be paid in a lump sum unless you elect another payment option that provides for payments that equals or exceeds your required minimum distribution amount more than 30 days prior to your payment date.

Vanguard offers fixed annual payments (2‐30 years), lump sum and required minimum distributions."

 

As of bankruptcy, this plan is with a prestigious University, though everything is possible.

I just wonder how much of a tax advantage this would be long term when I start taking distributions. Also, whether it would make more sense to pay the taxes on that money now and invest on a taxable account. If I am not mistaking, WCI recommends investing on the 457 before taxable accounts.

[JR]

Thanks DMFA. BTW, what is the difference between VTSMX/VGTSX and VTSAX/VTIAX? I feel guilty cause I know I should be able to figure that out with more time and reading. I was able to go through "The Bogleheads' Guide to Investing" and "The Four Pillars of Investing" last summer while vacationing in Anguila, but I swear I need to read them again. Now I understand the argument of doctors not having time for financial education. Clinical duties, sick patients in-house, patients calling, lectures to residents, lectures to physicians, writing papers, taking care of the family and spending time with your kids, ...

[SomeRandomGuyOnline]

Hey, JR.  The difference between the two groups is that VTSMX/VGTSX are "investor shares" while VTSAX/VTIAX are the "Admiral shares".  Investor shares require lower initial investments ($3k) but have a higher expense ratio.  Admiral shares have a higher initial investment requirement ($10k) but lower expense ratios when compared with their investor share counterparts.  Their holdings, however, are identical.

[artemis]

SomeRandomGuyOnline wrote:

Hey, JR.  The difference between the two groups is that VTSMX/VGTSX are “investor shares” while VTSAX/VTIAX are the “Admiral shares”.  Investor shares require lower initial investments ($3k) but have a higher expense ratio.  Admiral shares have a higher initial investment requirement ($10k) but lower expense ratios when compared with their investor share counterparts.  Their holdings, however, are identical.

Click to expand...

And Vanguard will automatically convert your Investor Shares into Admiral Shares once the balance invested in the fund rises high enough.  So the disadvantage of buying Investor Shares is temporary, as long as you continue to invest regularly.

[DMFA]

JR wrote:

Thanks DMFA. BTW, what is the difference between VTSMX/VGTSX and VTSAX/VTIAX? I feel guilty cause I know I should be able to figure that out with more time and reading. I was able to go through “The Bogleheads’ Guide to Investing” and “The Four Pillars of Investing” last summer while vacationing in Anguila, but I swear I need to read them again. Now I understand the argument of doctors not having time for financial education. Clinical duties, sick patients in-house, patients calling, lectures to residents, lectures to physicians, writing papers, taking care of the family and spending time with your kids, …

Click to expand...

SomeRandomGuyOnline wrote:

Hey, JR.  The difference between the two groups is that VTSMX/VGTSX are “investor shares” while VTSAX/VTIAX are the “Admiral shares”.  Investor shares require lower initial investments ($3k) but have a higher expense ratio.  Admiral shares have a higher initial investment requirement ($10k) but lower expense ratios when compared with their investor share counterparts.  Their holdings, however, are identical.

Click to expand...

Yeah.  And on those small amounts - say $10,000, the point at which you could upgrade to Admiral - you'd be losing out on a massive $11/year using VTSMX instead of VTSAX ([0.16% - 0.05%] * 10,000)  and a horrendously huge $7 ([0.18% - 0.11%] * $10,000) for using VGTSX instead of VTIAX.  So by the time you make that second $5,500 contribution/conversion and upgrade to the Admiral, you'll have missed out on roughly the equivalent of two McDonald's value meals for you and your spouse over the span of a year.

Non-sarcastic version: at that small amount, the still-very-small-but-higher expense ratio matters very little.  It's OK to hold Investor Class with small amounts.