mike232232 said:I am over the income limit for ROTH or tax deferred IRA, but I can contribute to taxable IRA regardless of my income...Right, as long as you are under 70 1/2 and have compensation income.
the question is, if I do that can I convert the taxable IRA to ROTH next year due to the loophole that is coming in effect in 2010????Yes. It's been discussed extensively in this forum, including posts on it in this thread dating back to 2006; you can start by searching for "2010".

The taxable income on the conversion is based on the total value and total basis (after-tax contributions) in all of your traditional IRA's; it doesn't matter how you split them up. If you have made $10,000 in after-tax contributions and the account value is $12,000, then you'll have $2000 of taxable income.

If you convert in 2010, you have a choice: it's either all taxable as 2010 income, or half as 2011 and the other half as 2012 income. You have until you file your 2010 return to decide, in case rising tax rates make the deferral a bad idea for you. In later years, the income is taxable for the year you convert.

You could consider making after-tax contributions to your 401(k) plan, if it allows them, to get more cash into your new Roth IRA.

cameron2003 said:The whole concept of tax deferral is bogus in many instances. It is quite common to be in a higher effective tax bracket when you are retired than when you are working. A very common example is the person who retires and buys a house for cash. That person no longer has a mortgage deduction. Effective tax rate for that person when working will very likely be lower than when the person is retired, even if income is substantially lower when retired.As was attempted to be explained 2 weeks ago:

1. Tax deferral is not "bogus" no matter where your tax rates are heading. Deferring income for a long period through a 401(k), a deductible IRA contribution, or any similar special account will still leave you with more money, after taxes, then giving up that deferral even if the rate applicable at withdrawal is moderately higher than the rate at contribution. It's just that a Roth IRA, Roth 401(k), etc. would be even better if your rate will be rising. But if you have no opportunity to contribute to investments of those kinds, you are still most likely best off making some kind of deductible investment, even if your tax rate will be going up.

2. The kind of "income" that matters for tax decisions is taxable income. Paying mortgage interest just reduces your taxable income. If, because you will no longer have a mortgage, you expect your taxable income to be higher when you're retired than today, it's reasonable to expect your tax rate to be rising and, therefore, a Roth IRA to be a better choice than a traditional IRA. But unless the difference is very large (like, if you expect your tax rate to be zero for a long time), a traditional IRA is still better than paying tax on your investment income every year. In any case, people living the kind of frugal lifestyle advocated in this forum have a decent shot at having a substantial taxable income while retired; people who save at the pitiful rates common today (even in this so-called frugal age) have very little chance of that.

3. It can indeed be tricky to figure out precisely one's total net marginal tax rate, if you're affected by things like the alternative minimum tax, the nonlinearity of the taxability of social security, itemized deduction phaseouts, phaseouts and ineligibility for various credits, and other complicated rules. Mortgages and other simple deductions pretty much just change one's income (at least if you'll be itemizing either way). If you have gross income of $100,000 and deductions of $30,000, then you will have taxable income of $70,000, the same as someone who earns $70,000 with no deductions; you can just think of that as your income.

4. The ratio of one's tax to one's income (however defined) is useless trivia, not helpful for tax planning.

It really is bogus to think I am saving on taxes when I pay 11% effective marginal rate while I work with all my deductions and more like 25% (at least) when I have no deductions and my income is lower. How is that non-bogus?

cameron2003 said:It really is bogus to think I am saving on taxes when I pay 11% effective marginal rate while I work with all my deductions and more like 25% (at least) when I have no deductions and my income is lower. How is that non-bogus?IF your tax rate were currently 11% and was expected to rise to 25%, THEN using a Roth IRA would be a better choice than a traditional IRA for you. If, for some reason, you were unable to contribute to a Roth IRA, you might even be better off with fully taxable investing than with deferring some tax. That would not make tax deferral "bogus." Moving to North Dakota would not be my best choice at the moment; that doesn't mean the state is somehow not real.

Tax deferral is always a good deal if it lasts long enough; the question is just how long. If you invest $5000 in a traditional IRA today, and it earns 5% per year, and you pay 25% on withdrawal in 30 years, you'll be left with $16,207.28 after tax. If you bought the same investments today, after paying an 11% tax this year and every year for the next 30 years, you would be left with very slightly more -- $16,429.08. But that's assuming that your tax rate suddenly jumps by 14 percentage points after 30 years; if the rise is more gradual, the IRA will win.

With a more reasonable tax rate rise, tax deferral will win by a lot even if your tax rates are lower today than in the future. If your tax rate while working was 20%, for example, taxable investing would have left you after 30 years with only $12,973.59, losing by a lot to the IRA.

So if you're only paying 11%, and don't expect that to change for 30 years, tax deferral is slightly bad for you. But I don't think your tax rate numbers are correct, and I don't think you understand what "effective marginal rate" means. It's the derivative of tax with respect to income. How did you calculate that? Are you in the 10% federal bracket, and pay 1% to a state? That would imply federal taxable income of no more than $8350 (if you're single). Unless it is partially phased out, affects your decision to itemize, is hit by AMT, or some other weird thing is happening, your mortgage is just a reduction in your taxable income, and will not give you that tax rate unless it's bringing your income down below 5 figures.

If you would like to share your taxable income for last year, I'd be glad to help you correctly calculate your effective marginal rate. I would give very strong odds it is much higher than 11%, if you're able to afford mortgage payments anywhere outside of Detroit.

cameron2003 said:effective marginal rate = total tax / total income. So if I make a $100,000 and I pay $11,000 to Uncle Sam, my effective marginal tax rate is 11%. If I defer $10,000 I save $1,100 in taxes and I get to pay $2,500 when I take my money (25%).I think we're beginning to understand the confusion.

The amount of tax you save by deferring $10,000 does not equal (total tax/total income)*$10,000. It just doesn't.

Let's just say that, hypothetically, in 2010, the tax brackets were: first $80,000, 0%; above $80,000, 50% of the excess. You planned to retire in 2011, when the tax system was going to become a flat 25% tax, where it was expected to stay for good. Your 2010 income, before whatever this tax deferral opportunity was, will be $100,000. You can either defer $10,000 to 2011, or not.

Total tax/total income in 2010 = 10%, assuming you don't do this deferral. Total tax/total income in 2011 = 25% for everyone.

Does that mean you shouldn't do it? Of course not. By deferring the income you lower your 2010 tax by $5000 at the cost of increasing your 2011 (or later) tax by $2500. If you're not interested in that opportunity, this isn't the right forum for you.

Thats bogus. In fact its bogus to the max.Indeed.

motleyfool

Q. What's the difference between a "marginal tax rate" and an "effective tax rate"?

A. Your marginal tax rate is the rate at which your last and your next dollar of taxable income are taxed. It's not the rate at which all your dollars are taxed. It's the maximum rate you're paying on any of your dollars of taxable income. For example, according to the rules at the time of this writing, the marginal tax rates for single filers are 15%, 27.5%, 30.5%, 35.5%, and 39.1%.

Remember that your marginal tax rate only deals with the specific tax on your income.

...

after considering the jumble of other taxes and credits, your marginal tax rate may lose a bit of its relevance. Which is why you'll want to take a peek at your effective tax rate. Your effective tax rate reveals the average rate of taxation for all your dollars. It's your total tax obligation (including your income tax and any other additional taxes and/or credits), divided by your total taxable income.

After all is said and done, it is very likely that your effective tax rate will be higher or lower than your marginal rate.

Quick question.

I had made a Tradition IRA contribution a few years ago, but was unable to take a full deduction for it. (Have to look at my taxes for break down) Does that mean that say in that year only 3k was deductible out of 4k, so the 1k as a percentage when i take it out at retirement would be tax free?

So as a complete example. Say i put in 10K total, but 1k was not deductible. So at retirement, 10% would be tax free, but 90% would owe taxes?

RedHotLama said:Quick question.

I had made a Tradition IRA contribution a few years ago, but was unable to take a full deduction for it. (Have to look at my taxes for break down) Does that mean that say in that year only 3k was deductible out of 4k, so the 1k as a percentage when i take it out at retirement would be tax free?

So as a complete example. Say i put in 10K total, but 1k was not deductible. So at retirement, 10% would be tax free, but 90% would owe taxes?
First, be sure to fill out and file Form 8606 with your tax return at the end of the year to establish that you have an after-tax contribution. If you failed to do so, you can still find old forms on the IRS web site and do so now. Whenever you need to take a distribution you'll also need to file Form 8606 to calculate how much of your distribution is taxable.

Your calculation would be correct if there was no growth in the account over the years. Earnings are before-tax, so that makes it a little more complicated, but you have the right general idea.

So let's take your example and factor in some earnings. Let's say you contributed $10k total, $1k of which was non-deductible, and you had $10k of earnings. So your account is now worth $20k. So your non-deductible contributions are now $1k/$20k or 5% of your account. That means that 5% of your first distribution would be assumed to have come from non-deductible contributions and be tax-free. Your non-deductible total (also referred to as your "basis") would then be reduced by the amount you took out. In subsequent years, the lower basis would be used to determine the taxable percentage. In other words, the non-taxable total of your distributions would never exceed $1000.

Look at Part I of Form 8606 and do some "what if" calculations to see how it works.

naas said:Is/might there be anything preventing me from opening a 403b account for the sole purpose of immediate conversion to Roth IRA to side-step the Roth IRA contribution limit (and what are the limitations on doing this (time window etc))?You can't just convert (in place) anything except an IRA. With a 403, as with a 401(k) or other qualified plan, you can (if you meet the income limit, which goes away in 2010) roll over to a Roth IRA, which has that effect. But you have to be able to withdraw in order to be able to roll over. 403 plans are a bit complicated (or at least obscure), but, in general, they're going to be subject to withdrawal limits similar to 401(k)'s: you won't be able to withdraw (or roll over) your contributions before you're 59 1/2 unless you leave your employer.

Does your employer offer a Roth 403(b) option? That would be perfect for you: the contributions are taxable now, but that doesn't matter to you, and no tax at withdrawal as long as you meet the requirements (which are similar to those for Roth IRA's).
My current MAGI is 0 (grad student with a mortgage). Hopefully within 2 years I will be in a higher tax bracket. I had ignored the 403b option at work until today, because it seemed like bringing more taxes on myself with no benefit. Which reminds me of my follow-up question: if I try this conversion trick, will I be bringing more taxes on myself with no benefit after all? For background, both 403b (opened today) and Roth IRA are currently with fidelity.If you are able to convert while your income is low -- for example, if you'll be leaving this employer before your income rises -- then you'll get a real benefit. But definitely look into whether you can just make Roth 403(b) contributions instead.
Oh yeah one last question: is the conversion itself difficult, like will I be spending 30 hours on the phone and filling out paperwork?The conversion itself is no problem, but it can be a bit of a pain to do a transfer from an employer plan to an IRA (if you're eligible). But having it all at Fidelity should definitely help a lot.

Hello, I have searched on the internet and in this thread, but I couldn't find a definitive answer. Can you roll-over your 401k from your employer if you are still employed by said employer and NOT be taxed on the roll-over? I've found on the net that there is such a feature as an "In-Service Withdrawal", that allows you to rollover (or otherwise withdraw) employer contributions, or employee (after-tax or rollover) contributions, and you can do so without any required taxes or penalties.

Any pre-tax salary deferrals are still NOT eligible to be rolled over without penalty per existing law.

Is the above accurate? If so, according to what I found i'd still need to see if my plan allows this "In-Service Withdrawal". I would like to move out at least SOME of my money from my employer's 401k and move to Vanguard for obvious reasons.

Thank you!