ROTH/Traditional or Both

[Diolla]

I got a surprise when I did my Taxes this year as it turns out I can contribute to a Traditional IRA and get the tax break.

Details- I work for the State and have a pension fund which they take 4% out of my paychecks for. I can retire with full benefits of 70% of my final average salary in 6 years.

I have a deferred compensation plan (gov't 401k) with no match that currently has about $10k in it.

I had planned to open up a ROTH IRA this year but found out that I can contribute to a Traditional up to the difference between the $4000 max and the amount going into my pension. Right now $1640 a year goes to my pension so I could put $2360 into a traditional IRA and it would be deductible.

My pension will be taxed by the Feds but not the State when I get it.
My Deferred Comp. will be taxed by both.

Does it make more sense to put my entire $4000 in a ROTH so I will have some untaxed earnings in retirement? I plan on leaving the State in 6 years (at 52 years old) and working my side business during retirement. I currently live off less than my pension will be.

Any opinions?

[jIM_Ohio]

Originally Posted by Diolla

I got a surprise when I did my Taxes this year as it turns out I can contribute to a Traditional IRA and get the tax break.

Details- I work for the State and have a pension fund which they take 4% out of my paychecks for. I can retire with full benefits of 70% of my final average salary in 6 years.

I have a deferred compensation plan (gov't 401k) with no match that currently has about $10k in it.

I had planned to open up a ROTH IRA this year but found out that I can contribute to a Traditional up to the difference between the $4000 max and the amount going into my pension. Right now $1640 a year goes to my pension so I could put $2360 into a traditional IRA and it would be deductible.

My pension will be taxed by the Feds but not the State when I get it.
My Deferred Comp. will be taxed by both.

Does it make more sense to put my entire $4000 in a ROTH so I will have some untaxed earnings in retirement? I plan on leaving the State in 6 years (at 52 years old) and working my side business during retirement. I currently live off less than my pension will be.

Any opinions?

My advice would be if you can afford the Roth (meaning you have the money now and contribute) it is "best bet". My blog has great detail on this. The short answer:

A Roth is "dense" money. You have paid taxes on it already, so the 4k in a Roth beats 4k in your pension, traditional IRA or taxable account. If you can afford the Roth, it makes sense more often than not.

However if you invest the $2360 into a deductable IRA, what would you do with the tax savings? This also affects the end result. If you would spend the refund difference, then Roth is better. If you invest the difference, the answer becomes grayer.

The gray portion depends on current tax rates for you, what you would invest in, and how long it would stay invested.

[Diolla]

This is essentially what is 'confusing' me. I could put the 2360 in a traditional the leftover 1640 in a roth and the tax savings in my deferred comp therefore giving me more to invest. I would not spend the tax savings because I don't need to.

However I don't expect a fall in income at retirement so I am worried about having too much coming from deferred tax accounts. My AGI this year put me in the 15% tax bracket as I have alot of things taken from my check before taxes. I expect I will be in a 20% tax bracket in retirement since I will be single with no dependents and will not have the tax advantage of having health ins & healthcare taken out before taxes like now.

Right now I am leaning towards just putting the whole $4000 in a Roth.

Also the money would stay invested until I needed it since my pension will easily cover my day to day living needs. It is hard to say when that might be. I would probably invest in index funds.

[jIM_Ohio]

Originally Posted by Diolla

This is essentially what is 'confusing' me. I could put the 2360 in a traditional the leftover 1640 in a roth and the tax savings in my deferred comp therefore giving me more to invest. I would not spend the tax savings because I don't need to.

However I don't expect a fall in income at retirement so I am worried about having too much coming from deferred tax accounts. My AGI this year put me in the 15% tax bracket as I have alot of things taken from my check before taxes. I expect I will be in a 20% tax bracket in retirement since I will be single with no dependents and will not have the tax advantage of having health ins & healthcare taken out before taxes like now.

Right now I am leaning towards just putting the whole $4000 in a Roth.

You could save the refund on the $2460 now, it will cost you "sooner or later". Paying the tax costs you something now, and according to current tax law, NOTHING later.

If you know for sure you'll be in a higher bracket later, use the Roth. You answered your own question. Do you know what refund difference is? I think we're talking about maybe three hundered dollars or so?

15% of 2450 is ~$360. The investment expenses on the $360 do not make this easy to come out ahead deductable.