Ok, bear with me. I’m not very savvy about these things.
My oldest sent me his tax info for me to do his taxes. I’ve done this for him and I do it on turbotax, it’s pretty easy when they don’t have a lot of complex things going.
Anyhow, he owes money again. I’m wondering if he opens an IRA he could reduce the amount of taxes he owes for 2014 (turbotax suggested it). He has a 401k and contributed $4800 to that last year. Can he open a ROTH IRA and contribute money to that also?
This one I am sure has plenty of money sitting in the bank. So he has money to put in a ROTH.
Also does anyone have any idea how much he needs to contribute to reduce the money he owes the IRS. As it stands right now, he will owe the IRS around $1000.
A contribution to a regular IRA will reduce your taxable income a small amount. I suggest you play with the numbers since you are using a software program. Enter varying IRA contributions and see how that affects your bottom line.
A Roth IRA contribution is probably best, but it is made with after tax dollars so it won’t reduce what he owes, unless he qualifies for the Saver’s credit.
With plenty of money sitting in the bank, and based on the limited information provided, he could pay the balance due, decrease his exemptions on his W-4, increase his 401k %, contribute up to $5500 for 2014 to the Roth IRA, and start reading the Mr. Money Moustache forums or Bogleheads.
Ok, so a ROTH won’t help at all. I will advise him to increase his contribution to the maximum. It looks like he is almost there since last year it was $4800. The max is $5500, I thought it was $5000. I’m sure he’s contributed the max for his match.
I’ll play with the numbers and see what I see. I didn’t know if he could max out his 401k and open an IRA.
Well, the 401k max is up to $18k per year. Do you mean the max to get full matching at his company? Also consider Roth 401k. Is he in the 15% or 25% tax bracket?
While your son may not like the idea of owing $1000, unless he makes a 2014 IRA contribution, it is too late to do anything else. However, this is the time to make a plan for 2015. If S has AGI (adjusted gross income) over $131,000 then he cannot contribute to a Roth IRA and thus contributing to an IRA would reduce his tax liability.
Investment advisors generally advise the following order, if a 401k with a company match is an option:
Fund 401k to take full advantage of company match, since the company match = free money.
Max out Roth IRA, $5500, as long as they have that much earned income, but not income over the allowable limits to contribute to a Roth ($131,000 AGI for filing single).
Go back to 401k and max out annual contribution - federal limit for 2015 is $18,000 annual contribution, but an employer may impose a lower annual limit.
Invest outside of a retirement vehicle.
All of this assumes that there is adequate savings to cover short term needs.
Good post at #7
Too late for this year, but for next year - what kind of health insurance does he have?
Does his employer offer a flexible spending account and would it make sense for him? If he keeps track of medical expenses this year he could project whether one of those “use it or lose it” accounts make sense to decrease his taxable income.
Do you itemize when you do his taxes? If yes, does he keep track of charitable donations?
Firstly, he’s not concerned about owing money to the IRS. I wanted to explore options for him if there was something he could do to decrease his tax burden. He paid more last year out of pocket and knew he would have to. He can change his withholding, but I wanted to present him some options and give him some advice.
I’ve been reading the retirement thread and wondered if there were things a younger person could do.
My S is thinking of and probably will buy a house at the end of this year. His employment has been stable but the location has not but they are thinking he is going to be in this spot for a while.
No problem with reaching the AGI max, lol! He’s doing well but not that well.
He has employer based health indurance but not many problems so I think he would not have any need of a flex fund.
If he’s going to buy a house this year he will definitely itemize, so he should keep track of charitable donations.
A Roth IRA is good to start while young, in addition to a 401(k).
When he has college aged kids he’ll be glad if the bulk of his investments are in 401(k) & Roth, as well as when he retires.
Taking a stab at the question: a Roth has the advantage that you can take out the contributions without a penalty if you need the cash. Also, you generally have more control on where your mpney gets invested. Usually the employer doesn’t give many choices for a 401(k).
In retirement, having a mix of Roth & 401(k) to draw on also gives you flexibility in taxes.
@ManhattanBoro, even though Roth IRA contributions are in after-tax dollars, distributions ARE NOT taxable. 401K contributions are in before tax dollars, but distributions ARE taxable. The difference in the distributions is the key, especially for someone who is young with many years for contributions and growth. A holder of a 401K must take required minimum distributions by age 70.5, whereas there are no required minimum distributions for a Roth IRA for the account holder. If the Roth IRA is inherited by anyone other than a spouse, required minimum distributions must be taken. Here is just one of many references that suggest the same order of investing: http://time.com/money/3404604/401k-roth-ira-max-out-first/
Disclaimer - I am not a CPA or financial planner. I just really like this stuff. I have also recently settled my Mom’s estate which involved 2 inherited IRAs and an inherited Roth IRA.
Another note, is to see if he has a roth feature in his 401k plan. A lot of plans now have Roth bucket of money within the 401k. A note on the MRD(Minimum Required Distribution) You have to take it the year AFTER you turn 70.5, not the year of.
Since he is young and in the 15% bracket, I’d go with all 401k Roth and Roth IRA, as much as he can manage up to the limit of $18k Roth 401k and then $5,500 Roth. Depending on your finances, you could gift him the Roth money for 2014 and or 2015, plus an additional amount up to $3000 toward the house down payment.
Depends on the time of year he purchases the house and how much he borrows and what the property taxes are. You can’t imagine how many people assume because they bought a house that they will get so much money back the following year. Not if they buy in December.
At his age, even if it means he pays more tax, a Roth IRA or 401-K is by far the better option. Keep this in mind: Even if he were in the 28% tax bracket, the tax on $5,500 is going to be far less than the fact that there will be NO tax on the earnings when he retires. How much will that $5,500 have grown by the time he’s ready to need it? And the other HUGE benefit is that if he’s being this responsible now, chances are he won’t need it at 70.5. Then he won’t be required to take it out and will keep his income lower, thereby paying less tax on everything else.
Right, he might not be able to itemize if he buys the house in the later half of the year. Also it could be smart to postpone paying the real estate taxes until the next year (after calculating his deductible amount based on the number of owned) if not over the limit to itemize for his filing status.
CincyGal (comment #13)–
Thanks for the explanation and the link. Understand and appreciate your interest in this. So-
The key factor is low tax bracket at the time one sets the money aside for retirement.
Rule of thumb for low bracket: After matching employer’s contribution, Roth IRA before maximum contribution to 401k.
Now, can you (or anyone else) address the following:
The Roth 401k seems to complicate the picture.
I assume similar to a Roth IRA, one pays taxes the year of deposit into a Roth 401k. Any stipulations about how much money can go into both types of 401k options? And, whether one plan has precedence, e.g. must X-amount first go into the 401k before the Roth 401k.
Employers can offer both 401k and Roth 401k options, but not all offer a Roth 401k. I would definitley recommend a Roth 401k for a young person if it is an option. Because the employer match has not been taxed, that money is is subject to taxes upon withdrawal. There are no income limits for participation in a Roth 401k like there are for a Roth IRA.
Total personal contributions to a 401k (whether Roth or traditional) is currently $18,000 per year for those under age 50. If an individual has both a Roth and traditional 401k, the total can still not exceed $18,000/year.