What would you do? Re: IRA, taxes, & down payment on home

[timers]

I have a question re: what I should do related to my taxes this year.

Bit about me:
25 y/o
15K emergency fund/savings
2500 in rollover IRA (old employer)
No debt
Income 67k year
Expenses $1400/mo

In 2010, I contributed only $773 to my employer sponsored 401k. I left that job in August, and my new employer doesnt offer a 401k so I converted this to an IRA. Both are with Fidelity.

I played with opening an IRA last January, funded it with 5k then needed the funds (dont ask) so I pulled them out. However, while I intended to build up 2009s amount, I actually funded 2010 with $300. Long story short, I can still contribute $4700 to my IRA or Roth IRA which is still open. Though I intend to max out my contributions to 5k for both this and next year, should the $4700 contribution be made to IRA now so I can deduct this from taxes?

If I contribute $4700, my return will go from roughly $300 to roughly $1,900. I figured it'd be nice to have the $1,900 now vs the $300, and have my contributions for 2010 be complete and nearly all (4700) in the traditional IRA.

My goals are to in the next 12-18 months, have enough $ for a down payment on a home. I want to put 20% down, and am looking at homes around $150K. This is a 30K down payment. I am aware I can take up to $10k from this IRA, and only have to pay taxes on it but not the early withdrawal penalty of 10% if spent in 120 days. My question is whether or not its worth to even consider this, or just to put the $4700 somewhere else (eg. other investments, possibly Roth IRA for 2010, brokerage accts, etc).

I hope this all makes sense, I know its long.


Option 1:
Contribute $4700 to trad IRA to get back larger tax return (1900)
In future, look to pull down payment funds from IRA for home and pay taxes on this as income

Option 2:
Contribute 0 to trad IRA now and get back smaller return (300)
Invest funds elsewhere
In future, use these funds towards down payment on home but not have to pay any taxes on income received from IRA withdrawal

[disneysteve]

I think you need to step back and look at the overall picture.

1. Set aside a 6-month emergency fund. At $1,400/mo. in expenses, that is $8,400. You've got that. Great. This doesn't get touched. It isn't part of a down payment. It doesn't get used to fund retirement accounts.

2. Your home purchase should ideally be no more than 2.5 times your income. For you, that's $167,500, so the 150K range is great.

3. Retirement accounts are for RETIREMENT. That's it. Nothing else. Don't plan to put money into a retirement account just to turn around in a year and take it back out. You've already made that mistake once. Don't repeat it.

So where does that leave you? Ideally, you want to be funding retirement AND saving for your down payment. Retirement savings should be 15% of your gross, so $10,000/year for you. At the very least, you should max out your IRA each year while simultaneously saving for the home. Once you are in the home, you can ramp up the retirement savings to hit that 15% mark.

After setting aside your EF from your 15K in savings, you are left with $6,600 to use toward the house. You need another $23,400. You should be saving 20% of your income, or $13,400/year. If $5,000 of that goes to the IRA, that leaves $8,400 to use toward the down payment. That means you are closer to 3 years away from having a $30,000 down payment. So i think your 12-18 month timeline may be unrealistic unless you are able to save a lot more than 20% of income. Lots of people do, so that isn't an unreasonable goal. Ask around at this forum and you'll find people who routinely save 30-40% of their income.

[MonkeyMama]

I wouldn't put a dime into retirement that I was going to use in the next year or two. A lot of hassle for no reason. (You'll get a tax break now, but will pay when you withdraw, etc.). Basically, there is no real benefit to doing so.

If you are saving for a down payment in 1-2 years, I would simply put the money in a cash account. An online savings account. Maybe a C.D. or a C.D. ladder. I wouldn't put it in a ROTH, an IRA or a brokerage.

[jpg7n16]

my plan would be sort of a summary of the above with slight changes.

1- lower EF funds to $5k, put excess $5300 in your downpayment savings (leaves 4700 cash)
2- $4700 for IRAs today (for year 2010). Since you don't have a 401k, you need some form of retirement savings. $6700 will be 10% of your income.
3- Save for house in securities with 12-18 month horizons. Probably money market accounts, or CDs.


And for your IRAs, I would do $2500 to traditional, and $2500 to Roth. Since for 2010, you've already done $300 to traditional, then I would do $2200 to traditional and $2500 to Roth.


Reasons for funding the IRA at 10% while saving for downpayment: in my view, retirement is a higher priority than owning a home.

[timers]

my plan would be sort of a summary of the above with slight changes.

1- lower EF funds to $5k, put excess $5300 in your downpayment savings (leaves 4700 cash)
2- $4700 for IRAs today (for year 2010). Since you don't have a 401k, you need some form of retirement savings. $6700 will be 10% of your income.
3- Save for house in securities with 12-18 month horizons. Probably money market accounts, or CDs.


And for your IRAs, I would do $2500 to traditional, and $2500 to Roth. Since for 2010, you've already done $300 to traditional, then I would do $2200 to traditional and $2500 to Roth.


Reasons for funding the IRA at 10% while saving for downpayment: in my view, retirement is a higher priority than owning a home.

Thanks for everyones comments so far. This has been helpful. Re: the above post, I like the advice though you mention in point 2 contribute 4700 in cash to IRAs today for 2010. Your comments below that are just how to break it up? I did 300 to Roth already for 2010. I was thinking of doing $4700 all to trad IRA for 2010 to bring my total to around $7500 with existing balance, then build the Roth IRA from 0 and max out 2011 5k contribution within the next 2-3 months.

Once Roth is maxed, all additional savings goes to EF and down payment fund. Most likely a mix of P2P lending, high yield savings (Smartypig) or brokerage account through Vanguard invested in a wide mix of ETFs.

[jpg7n16]

Re: the above post, I like the advice though you mention in point 2 contribute 4700 in cash to IRAs today for 2010. Your comments below that are just how to break it up?

Yup. I usually suggest that people in the middle tax bracket do a 50/50 split between deductible and Roth IRAs (or as close as possible while saving 15-20%). Usually, that's split between 401k and Roth - but you can't do a 401k.

That's my personal suggestion. Do half and half. Gets half tax break now, and half tax free income later.


And once you've saved up for your downpayment, you should try to save 15-20% for retirement. That'll be much more than the $5k. But since once these years are gone, it's impossible to go back and contribute - I think it's better to fund IRAs now in the absence of a 401k.

It's only $5k which is less than 10%.

[timers]

When you say save 15-20 for retirement once the down payment is done and IRAs fully funded. What do you suggest? Just a brokerage account?

[jpg7n16]

When you say save 15-20 for retirement once the down payment is done and IRAs fully funded. What do you suggest? Just a brokerage account?

Yup. It's your only remaining option at that point (so far)

I agree with DS from another thread on here, that they should really up the IRA contribution limits for people not covered by a qualified plan at work. Maybe one day - but until then, brokerage is all you've got.

[disneysteve]

When you say save 15-20 for retirement once the down payment is done and IRAs fully funded. What do you suggest? Just a brokerage account?

Yup. It's your only remaining option at that point

Remember, that's 15% including the IRA contribution. So for you earning 67K, that's about 10K total toward retirement - 5K to the IRA and 5K to something else. Since the other 5K will be going into a taxable account, you want to try and stick with tax-efficient investment options. Index funds are generally a good choice. They have low portfolio turnover and typically pay out less in capital gains as a result. My taxable "retirement" account is in Vanguard's S&P 500 fund.

[timers]

Remember, that's 15% including the IRA contribution. So for you earning 67K, that's about 10K total toward retirement - 5K to the IRA and 5K to something else. Since the other 5K will be going into a taxable account, you want to try and stick with tax-efficient investment options. Index funds are generally a good choice. They have low portfolio turnover and typically pay out less in capital gains as a result. My taxable "retirement" account is in Vanguard's S&P 500 fund.

That's the ETF right?

[hard2figure]

I know you can't do this for the 2010 contributions but you might want to contribute to your ROTH IRA every month. Then you don't have to see large sums go at tax time and it will help to better balance out your buying power (Dollar cost averaging is the term).

Because of no 401k and your desire to buy a house. I'd say to try and max out your ROTH ($416/month) and then save the rest for your down payment. Ideally you should listen to disneysteve and save more for retirement but the desire to get into your own house is strong in the youth of today. Before you buy be sure you love where you are. You are now in a job that does not offer 401k options, are you sure you want to stay there? Maybe the answer is yes and that's fine! but it is so much easier to move closer to work or even change to a job in another area if you aren't tied to a house.

I'd recommend not continuing to use your IRAs for savings. The money you pay in penalty is actually setting you back. Figure out which is more important to you and don't try to trick yourself. If the money goes into "retirement" it should stay there. If you feel the house is more important then save it outside your retirement. I can see you can do the numbers and realize that you can get a larger refund if you put money into retirement, but pulling the funds back out later is actually hurting you more than the extra refund is helping you ... but I do admit to not having all of the numbers for your unique situation.

[disneysteve]

That's the ETF right?

Sorry for not responding sooner. I haven't been on the board much.

Personally, I own the mutual fund, not the ETF. ETFs weren't really around or popular when I started investing. Either that, or there were commissions for buying shares. It is only in the past couple of years that the no-commission ETF has come about. If I were starting today, I'd probably look at ETFs but I've been at this for almost 20 years so I'm all in mutual funds.

[whey2big4u]

May I ask what you do for a living? Sorry to ask but to make that at 25 is unheard of around my parts.But if you feel uncomfortable then it is okay

[disneysteve]

May I ask what you do for a living? Sorry to ask but to make that at 25 is unheard of around my parts.

I don't think that is an unusual salary at all for a 25-year-old. Assuming you graduate college at 21 and get a decent job, you will have 4 years of experience at that point. Engineering, finance, IT and other fields have pay scales in that range.