I’m 23, graduated from college in May 2016 and started working full time in June 2016. Given that 1) the position I took is for a 2 year time period, but vesting only starts after 3 years 2) that I would be self-financing the large majority of my own moving expenses, and 3) wanted to start getting my emergency fund up to scratch, I decided to fund a traditional IRA rather than invest in the company’s 401k – besides, I knew I wouldn’t be able to invest much more than $5,500 in a retirement account, anyway. I stayed at that job for only 7 months (for those doing the math, that means I left this month) and will be starting a new position at a company that doesn’t yet have a 401k in place for its employees. This means that for 2017, I don’t have the choice of a 401k or IRA, but rather a traditional or Roth IRA.
I do see my income increasing in the future, so I’m interested in having a Roth IRA rather than a traditional one. However, I’d like some advice about if/how to do a conversion. Given my gross income for 2016, the $5500 that I contributed to my traditional IRA is deductible. I currently have auto-deposits set up to keep funding the traditional account for 2017 and I have contributed $458.00 so far this year. For full disclosure, in addition to the $5500 I contributed in 2016 and the $458 I’ve contributed so far for 2017, I’ve earned $291.32, making for an account balance of $6,249.32 I’d definitely like to begin making Roth contributions ASAP, but I don’t know which of the following options is best.
Option 1: Leave the 2016 Contributions in a Traditional Account; Convert $458 to a Roth and Continue Funding the Roth for the Remainder of the Year
Using IRS Publication 590A, here’s how I believe this will work out
- Amount of IRA contribution for 2017 to be recharacterized: $458.00
- Fair market value of the IRA immediately prior to recharacterization: $6,249.00
- Fair market value of the IRA immediately prior to the time the contribution being recharacerized was made: $6,112.00
- Subtract line 3 from line 2: $137.00
- Divide line 4 by line 3. Enter the result as a decimal rounded to at least 3 places: 0.022
- Multiply line 1 by line 5. This is the net income attributable to the contribution to be recharacterized: $10.00
- Add lines 1 and 6. This is the amount of the IRA contribution plus the net income attributable to be recharacterized: $468.00
Based on these calculations, I believe I would have $468.00 converted from a traditional to a Roth IRA. In terms of my 2016 taxes, nothing will change – I’ll still show that I contributed the full amount and get the associated deduction. In terms of my 2017 taxes, I don’t anticipate having to pay any additional fees, as the conversion would be done by the trustee within the allotted time. I anticipate having to pay taxes on the earnings – $10.00 as calculated above – and nothing more, but please correct me if I’m wrong.
If the above thought process is correct, the only other complication I see with this option is sorting out what’s taxable and what’s nontaxable when it comes time to withdraw. However, if the two accounts are separate – a traditional and a roth – it shouldn’t be that complex, right?
Option 2: Convert the Entire Balance to a Roth and Continue Funding the Roth for the Remainder of the Year
The same publication above says this about converting by rollover any traditional to Roth IRA: “You receive a distribution from a traditional IRA in one tax year. You then roll it over into a Roth IRA within 60 days of the distribution from the traditional IRA but in the next year. For recharacterization purposes, you would treat this transaction as a contribution to the Roth IRA in the year of the distribution from the traditional IRA.”
If I go this route, I believe I’d have to wait until I’ve contributed the full amount for 2017 to take advantage of the fact that there’s no limit to how much money can be rolled over into a Roth IRA. Given that the rollover would count as a contribution, as I understand it, I wouldn’t be able to contribute anything additional (specifically, the $5,042 I’m planning on contributing throughout the remainder of 2017), as my contributions for the tax year would already be beyond the limit (although not “in excess,” thanks to the no limit on conversion).
Given that I’d be waiting until I’ve reached the yearly contribution max, I don’t really have all of the necessary information to run through the worksheet from 590A as I did above. If anyone could help me make an earnings estimate for a more accurate scenario, that would be great – you can assume that I’ll be contributing 458.00 every month for the rest of the year (including February), plus $4 extra dollars in December 2017 to hit the max.
Basically, I don’t have a good understanding of the outcome if I were to go with this option. But I imagine that this one would be the most expensive in the short term, as, when it comes time to file 2017 taxes, I’d have to pay the taxes on whatever earnings the account makes, as well as pay back the taxes on the 2016 contributions that will be reported as deductible on my 2016 tax. Obviously this is the most undesirable short-term solution, but probably the most desirable long-term solution.
Option 3: Don’t Convert Any of the Current Balance; Open a Roth and Contribute $5,042 Throughout the Remainder of the Year
I don’t think this situation requires nearly as much explaining as the other two. My 2016 contributions and their impact on my taxes would be the same as if I were to take Option 1. For 2017, I’d report the $458 contributed thus far as deductible, and then report the yet-to-be-contributed $5,042 as nondeductible contributions to a Roth. Referring to Option 1 again, I think the only potential complexity here would be determining what’s taxable/nontaxable when it comes time to withdraw, several years down the road.
I think this is probably the least complex solution, but also maybe the least beneficial? I’m not sure that this really brings much to the table when compared to the other options…
Anyway, I’d love some insight on 1) the correctness of the scenarios I’ve come up with and 2) what the best one to take would be. Thanks!
Submitted February 12, 2017 at 09:47AM by IRA_Help http://ift.tt/2lD29kq
