Roth IRA and 401k Plan at Same Time?
My 28 year old daughter has funded a Roth IRA for a number of years, actually since she had part time jobs (Starbucks) in high school.
She has funded it for 2012 already but now wants to join her company 401k mostly because she wants the federal tax benefit “defered income” of a 401k. Her and her husband (DINKS) are getting “killed” on income taxes. And yes for 2012 she had to contribute to a traditional IRA and then a Roth conversion last January.
Q. Can she fund both a Roth IRA and a company 401k in this year?
Additinally can anyone explain to me why your can put so much more annually in a 401k vs a Roth IRA ($3,000).
And as long as I am here what is the “limit” for 401k contributions. Is it fixed by the IRS or the PLAN or ??????
Thanks
Permalink Submitted by Alan Spross on Sun, 2012-10-14 02:09
IRA contributions fall under a totally different portion of the tax code (Sec 408) than qualified employer plans like 401k plans (Sec 401, 402g). Her maximum Roth IRA contribution is 5,000 but she can defer up to 17,000 to a 401k plan (IRS limit) subject to the plan rules. The plan may place a % limit of her gross income on how much she can contribute, and that may come out to be less than 17,000.
But there is a maximum modified AGI amount of 173,000 using their joint income tax return figures. Above that he Roth contributions are limited and above 183.000 she cannot contribute at all. Amounts she contributes to the 401k (pre tax) reduce her income and therefore make it more likely that their modified AGI would come in under the 173,000.
FInally, note that her Roth IRA conversion done in January will be taxable income, but it will NOT COUNT in their modified AGI because the calculation of MAGI includes subtracting out the conversion income.
Permalink Submitted by Richard Rea on Sun, 2012-10-14 03:33
Alan,
A little more details to help refine your answer. Thanks
My daughters estimated income for 2012 was $80,000 and on January 12th she made her 2012 annual contribution of $5,000 to her Roth IRA.
In February she announces she is marrying her long time boy friend in July 2012. His estimated income for 2012 is $140,000.
We are now at 2012 estimated income (all wages) of $220,000 MFJ. Ops that is over the maximun for making Roth IRA contributions for MFJ.
13 Feb 2012
Per the Feb statement (TDAmeritrade) on Feb 13th, “Transfer Recharacteization of current year form her Roth IRA to a new Traditional IRA account” Transfered out $5,288. Note: at this point and currently she has no 401k or anything else.
26 Mar 2012
Per the March statement TDAmeritrade, “Internal Transfer Roth Conversion (Under 59 1/2) from her new traditonal IRA back into the existing Roth IRA”. The TDAmeritrade entires just show the account numbers. Transferred back in $5,288.
The wedding went as scheulde in July of 2012.
This was all per discussion on this board in the 1st quarter of 2012. I guess I could look up the old string.
Q. Would you agree that this was necessary and done correctly?
Now during a visit last weekend she says, “Dad I think I need to start a 401k with my company as I/we hate paying all these federal income taxes. Note she/we live in a state (WA) with no state income tax.
That resulted ini todays post.
Permalink Submitted by Richard Rea on Sun, 2012-10-14 03:45
Alan says, “IRA contributions fall under a totally different portion of the tax code (Sec 408) than qualified employer plans like 401k plans (Sec 401, 402g).”
Yes I understand that but my question remains, “Can you fund both an IRA account and a 401k in the same year”.
Which now raises this question, “Can you fund both a Tradational IRA and a Roth IRA in the same year?”
Permalink Submitted by Alan Spross on Sun, 2012-10-14 04:16
Yes, you can make contributions to both as long as your income permits.
As a result of the higher joint income (for tax purposes they are considered married the entire year), it appears that this was recognized and her Roth IRA contribution was recharacterized to traditional IRA (TIRA) contribution that will not be deductible. That TIRA contribution was then converted to a Roth IRA. On their joint tax return there will be a Form 8606 with her SSN and it will show a 5,000 non deductible TIRA contribution and the 5,288 conversion amount.
This works fine as long as this TIRA was her ONLY TIRA account, and it did not hold any other balance than the recharacterized contribution. If that is the case her conversion income will only be the $288 in earnings. If she has another TIRA balance, her entire conversion will be mostly taxable.
Since she is now deemed to have made a TIRA contribution of 5,000, she cannot make a Roth contribution. People that are eligible for both types of contributions can only contribute a total of 5,000 but it can be broken up in any fashion between the Roth and the TIRA.
What she has done is often referred to as a “back door Roth IRA contribution”. It got its name because due to her income she cannot come in the front door (making a regular Roth contribution), so she makes a non deductible TIRA contribution and then converts it. She ends up with a Roth contribution after all, but it’s a two step process (3 if you have to recharacterize). So for 2013, unless something changes, she would just make a non deductible TIRA contribution and immediately convert it. But if she has additional amounts in a TIRA, she may not want to convert unless she is willing to pay taxes on the conversion.
Permalink Submitted by Richard Rea on Sun, 2012-10-14 15:55
Thanks Alan I think I have it figured out but let summarize my understanding.
First she has no “other TIRA”. The only retirement account she has is the 11 year old Roth IRA but there was a TIRA opened last year for the sole purpose to be used in the “back door” strategy. As far as I can tell it was created in Jan to receive the Roth rechartizeration and when the money was “convverted” back to the Roth IRA it was closed by TDAmeritrade as the balance in it was zero.
Summary
1) My daughter can continue to fund her Roth IRA using the “back door” process by making a “after tax contribution to a TIRA and then doing a Roth conversion”. Her income has no effect on this but to make it all after tax money.
2) She can open a 401k with her company which of course will be funded with before tax money and thus reduce her gross income for federal income tax purposes.
Permalink Submitted by Alan Spross on Sun, 2012-10-14 17:44
1) Correct. But if she ever rolls over a 401k to an IRA, that will be pre tax money which will make future Roth conversions mostly taxable.
2) Correct. It will also reduce their MAGI and make it more likely they could make regular Roth IRA contributions if their income were to drop below the 173-183 MAGI phaseout range. Note that many 401k plans now include a “Roth 401k” option. Of course, if she elects the Roth for all or part of her salary deferrals (up to 17k max total combined), these contributions are after tax like all Roth contributions and will not reduce her taxes or MAGI. Any company matching contributions always goes to the pre tax 401k account.
A Roth 401k has NO upper income limit for contributing, so it’s a way to get more than 5,000 (the IRA conversion) into a Roth per year.