Traditional IRA to Roth IRA question.

[AK2TX]

Hey everyone,

 

I have been thinking about ways to lower my AGI for the sake of also lowering my student loan payments while in residency. My wife and I have funded our Roth for 2017, but I feel it might make more sense for us to withdrawal our contributions for this year and fund the Traditional IRA lowering our AGI by $11,000 and qualifying us for a heftier saver's credit, which would give us $4,000 back on tax day!

My question is: would it then be okay to rollover our Traditional IRA amount into our Roth IRA’s in 2018 after we have received our tax returns, but prior to April 15^th? Is this kosher or tax fraud?

 

Thanks in advance for your time and reply!

[cgossage]

I think you might be misunderstanding the amount of the saver's credit.  The maximum a couple could get is $2,000 and that is only if your AGI is under $37,000.  You only get the 50% credit on the first $4,000 you have saved.  I'm guessing if you do a Traditional IRA it will put you in the 50% credit instead of the 20% credit which would be nice.

You can convert to a Roth at any time, so you could always go Traditional in 2017 and convert to a Roth on January 1st.  You will have to pickup income on whatever the value that's in the TIRA at the time of conversion, but you would still get to keep the credit.

[DMFA]

What is your AGI? Do you have an employer account? I ask because you'd need to make sure you could even deduct your Traditional contributions. Are you sure the tax benefit now is worth the tax hit later on withdrawal or conversion?

[AK2TX]

Thanks so much guys for the reply!

Taken from the IRS website:
The amount of the credit is 50%, 20% or 10% of your retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly).

We will be filing jointly.

AGI currently is about 46,000 and with 11,000 taken out in the form of contributing to a Traditional IRA this year now puts me right at 35,000, qualifly my wife and I for the $4000 savings credit .

I do not have any employer retirement accounts. I believe that the later tax hit of 1600 to switch from the Traditional to the Roth is totally worth it if I'm collecting $4000 credit and lower my student loan payments for another full year

[Dreamgiver]

Assuming everything you are saying is indeed correct, it is only worth it if you invest the 4k. Otherwise it is not. I'd get that credit and put it into your employer's 401k or 403b.

[AK2TX]

I now see that I was reading the IRS rules wrong. $2000 is the maxium benefit of the saver's credit like cgossage mentioned. Though converting my Traditional IRA to a Roth would be a $1650 taxible event at my 15% tax bracket, I would still be $250 ahead after recieving that credit, and more importantly this would be lowering my AGI by $11,000 leading to a $100 deduction in my student loan installment over the next 12 months saving me $1,200 over the next year. I think I am going to go ahead with this plan!

[DMFA]

Are you actually going to pay the loan back, or are you doing forgiveness like PSLF? If you're actually on the hook for it, then the lower payment into it isn't really "saving" you anything; rather it's costing you that same amount. Just be aware of that possible cost of paying less on debts.

[jfoxcpacfp]

AK2TX wrote:

I now see that I was reading the IRS rules wrong. $2000 is the maxium benefit of the saver’s credit like cgossage mentioned. Though converting my Traditional IRA to a Roth would be a $1650 taxible event at my 15% tax bracket, I would still be $250 ahead after recieving that credit, and more importantly this would be lowering my AGI by $11,000 leading to a $100 deduction in my student loan installment over the next 12 months saving me $1,200 over the next year. I think I am going to go ahead with this plan!

Click to expand...

Penny wise and pound foolish? With all due respect, I think you are looking at this decision in a vacuum rather than the overall context of your long-term plans. Agree with @Craigy that you need to understand the difference in paying less on your debt or owing less over the long term. Do you possibly have access to an HSA or any other means of income reduction? The best time of your lives for Roth contributions are while you are in a temporarily low bracket. That said, I understand that this has more moving parts than simply deciding whether to go Roth or deductible.

If you decide to go with the deductible, start by asking your custodian if they will simply reclass the contribution at inception, which would income taxes on the growth. To be specific, I should say it would delay income taxes on the growth.

[AK2TX]

To open up the can of worms!

Currently I owe about $250,000 with an average interest rate of 5.8% to the federal government. Roughly $1,208 per month of interest. I am in the REPAYE payment plan so the government subsidizes me what I can’t pay monthly based on AGI, family size, and poverty levels in the state I am from. With my current resident income, it is better to try and keep AGI as low as possible so my subsidy from the government is greater monthly. I do plan to do PSLF. My current monthly payment is $0 (since I only made grades and not dollars last year) the government will forgive half of my interest which is $604 and the remaining $604 will be added to my principle. I have effectively just took my large 5.8% and cut it to a 2.9%.

Now, next year they will use my taxes to determine what my payments will be. With an AGI of $47,000 payments are $189 while an AGI of $36,000, my payments are $97. Maybe I am complicating things…

I am grateful for your advice. Should I just continue to fund the Roth yearly for my wife and I while in residency and forget about lowering my AGI? I though I might fund a Traditional IRA for these years in residency and then prior to graduating convert/reclassify the Traditional IRA to a Roth. Is this advisable?

Thanks everyone for your help.

 

[jfoxcpacfp]

In the grand scheme of things, it's not going to make a lot of difference, kind of like debating over which credit card pays the best rewards. Either choice has its advantages and I'd say just make up your mind and move on. I have gone through enough worms on this one 

[cgossage]

I get that money is tight in residency, so every $ counts.  You could implement the strategy as outlined and it would free up some cash today which is always helpful when money is tight.  The only downside is realizing all of the income the year of conversion, and if the market appreciates you will be paying taxes on any gains in your account at that time as well.  Then again we could enter a recession and everything align for you in your strategy.  You would probably come out money ahead using your strategy if you are able to invest the tax savings you are receiving.

On PSLF, have you been staying on top of certifying your employment and are you certain you will be working for a non-profit after training?

In all of this, there is the right "finance" decision and the right decision for what you need to make ends meet right now.  Since you are already saving $11,000/year in residency I'm guessing you are going to be fine long-term with either choice.