Backdoor Roth IRA if on Tax Bracket cusp?

[littlefish]

Will doing a backdoor Roth IRA change your tax bracket?

[DMFA]

littlefish wrote:

It looks like I might be in the crosshairs of the tax reform (relatively low high-income earner in an expensive real estate market / high state tax). My expected W2-salary is in the $230k – $250k range and I max out my 403b and 457b plans. Would it be more beneficial to avoid doing the backdoor roth IRA moving forward if it could potentially drop my tax bracket?

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...in favor of what, exactly? You don't have any more tax-deferred options other than HSA (which you should be doing as well, if you can).

Roth is superior to taxable for retirement. You can't deduct traditional IRA contributions because you make too much (unless that changes with the coming tax code as well).

[jfoxcpacfp]

A backdoor Roth IRA is tax-neutral for the transaction. No deduction, no income. Over time, it is very big tax benefit if invested and managed properly.

[MPMD]

OP I worry that you are making the common mistake of thinking that when you hit a new tax bracket it is retroactively applied to all of your income.

You should always want to "hit another tax bracket" b/c that means you are making more money.

[The White Coat Investor]

littlefish wrote:

It looks like I might be in the crosshairs of the tax reform (relatively low high-income earner in an expensive real estate market / high state tax). My expected W2-salary is in the $230k – $250k range and I max out my 403b and 457b plans. Would it be more beneficial to avoid doing the backdoor roth IRA moving forward if it could potentially drop my tax bracket?

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Something is wrong with your reasoning. Stay with us until we figure out what it is.

I see no reason for you to avoid the Backdoor Roth IRA in your post. What is the reason you think you should avoid it? Are you thinking you could deduct a traditional IRA contribution instead? Because you can't. It's taxable, non-deductible traditional IRA, or Roth IRA and Roth wins every time out of those three.

[littlefish]

delete

[DMFA]

littlefish wrote:

Got it. My understanding from what you all are saying is that IRAs are not tax-deductible regardless of whether its Roth or Traditional and that even if I was to enter the higher tax bracket, it would only be a sliver of my income that would be taxed at this bracket, while the majority of my AGI would be taxed at the lower tier. Thanks

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You can't deduct Traditional IRA contributions if you have an employer retirement account (401k, 403b, etc) and make over $72k single or $119k married.

You can't make direct Roth IRA contributions if you make over $133k single or $186k joint (or at all of married filing separately).

The way tax brackets work is that different amounts of your income are taxed at different rates (marginal rates). When you move into a higher bracket, only that bracket is taxed at that rate. For instance, say you're married filing jointly, and your taxable income is $233,350 (top of the 28% bracket). You don't pay 28% on the entire amount. You pay:

• 10% up to $18,650 = $1,865


• 15% from $18,651 to $75,900 = $8,587.50


• 25% from $75,901 to $153,100 = $19,300


• 28% from $153,101 to $233,350 = $22,470


• $1,865 + 8587.50 + 19,300 + 22,470 = $52,222.50

Despite being at the top of the 28% bracket, your tax paid is 22.4% of your taxable income, meaning your effective rate (taxes divided by gross income, before your deductions, etc) is likely in the high teens.

Now say you make an additional $10,000 of income onto that, putting you into the 33% bracket. This does not cause all your income now to be taxed at 5% higher; only that $10,000 is taxed at that marginal rate, meaning an additional $3,300; $55,522.50 ÷ $243,350 = 22.8% of taxable income.

So, vis-à-vis IRA contributions at that level, it's a moot point because the only way to tax-advantage your IRA in that insurance is to do "backdoor Roth." But this demonstrates that barely crossing a bracket is not a very big deal, and that trying to take a deduction solely to get you down into the slightly lower bracket is not particularly fruitful, at least from the perspective of overall tax paid.

[ENT Doc]

Only thing I'd add is that after the $133/186k Single/MFJ cut-off there is a phase out.  So you can contribute to the Roth, but it phases out quickly.  Far more reasonable (and safe if income fluctuates) to not even deal with that and just do a backdoor Roth.  Agree with what everyone has said regarding your logic - there is no marginal effect here.  That money is being taxed anyway.  You have three options - non-deductible TIRA contribution, backdoor Roth, taxable.  Roth is clearly superior.