We've just about wrapped up our 2016 taxes. Finally. The past few years we've been fortunate enough to be above the MAGI threshold to contribute to a Roth IRA. Good problem to have, right?
Well, with 2016's taxes just about completed I was expecting us to be able to contribute to Traditional IRAs in order to lower our taxable income. Apparently, that's not the case. My understanding of the tax law is that we can only contribute a paltry amount, about $800 per IRA, because I had access to a 401k last year. Nevermind the fact that I was laid off in April so I only had access to it for about 1/3 of the year.
Since we are also somehow above the income limit for contributing to a Traditional IRA, since I had access to the 401k, that limits the amount of tax deductible contributions we can make to IRAs.
I was hoping to source the wisdom of the community to see what y'all think we should do.
Scenario 1: Contribute the max allowed, ~$800 per account, to Traditional IRAs and the remainder to Roth IRAs.
This changes our taxes from approximately $40 that we owe to about a $140 refund. However, it complicates our investments since we'll have such small amounts in the Traditional IRAs. Adding 2 accounts with only $800 each seems like it's not worth it to me and would just be more hassle than it's worth.
Scenario 2: Contribute the max allowed, ~$5,500 per account, to Roth IRAs only.
This would diversify our tax situation better and allow us to have a better mix of taxable, tax deferred and tax free accounts. However, as I mentioned earlier it comes with changing our tax status from around a $140 refund to owing around $40.
Scenario 3: Forego IRA contributions for the 2016 tax year entirely and use the cash that would have funded the accounts to pay down debt or buffer the emergency fund to allow more aggressive debt pay down in the coming months.
By choosing this we would end up owing approximately $40 in taxes which I'm fine with. However, we wouldn't get the account diversification by adding to either tax deferred or tax free accounts. We would then use that extra cash for debt reduction or just keep it in the emergency fund.
As of now for the 2017 tax year I don't have a 401k at work so we should be able to max out two Traditional IRAs for the current tax year. That would give us approximately $11k that is tax deferred in self-directed IRAs as well as reducing our taxable income for this year.
I'm currently leaning more towards Scenario 2 or 3. Frankly I like things to be simple and adding 2 additional accounts to keep track of that are only funded with ~$800 isn't that attractive to me, although for 2017 those accounts should be able to get a $5,500 boost each. Especially since it doesn't really move the needle in terms of our taxes: owing $40 vs getting a $140 refund.
*Update*
I have everything completed now and as it stands we can make $900 in contributions to 2 Traditional IRA accounts and $4,600 to 2 Roth IRA account. However, it swings us from paying $2 to the IRS to a $548 refund. Looks like the Traditional IRA's are getting funded.
**Final Update**
Everything is complete now. Here's where we stand we can contribute $990 each to 2 Traditional IRAs. That leaves $4,510 x2 that we can contribute to Roth IRAs depending on what cash we can scrounge up in the next week. By contributing the $990 x2 for the Traditional IRAs it moves our refund from $111 to $699.
**Final Final Update**
Nothing has changed regarding the IRA contributions that we can make. I know what brokerage I'll be going to for the 2 Roth IRA accounts as well as my Traditional IRA contribution. However, for the Traditional IRA contribution for my wife I'm needing to find the best place to brokerage to park that money. I need something that has low commissions, since we might only have $990 to invest in that account for the foreseeable future as well as free dividend reinvestment and no account fees.
For that account I'm considering Fidelity since they check all those boxes as well as provide several commission free ETFs including dividend focused funds. Vanguard would be another option with their suite of funds/ETFs and low fees. However, their dividend focused fund has an expense ratio that is double what Fidelity's is.
So my question to all of you is what would you do in this situation. Is it worth it to get as much tax benefit as possible? Is a Roth IRA better in this situation? Or would we be best served by using the cash for debt reduction or emergency fund buffering?
Please let me know in the comments below!
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