For some background to this post, see Starting from scratch - laying the groundwork.
My brother is a couple weeks into his new post-college job, and has received a couple paychecks. He's in the process of doing things that lots of recent college graduates have to do... open bank accounts, start retirement plans, sign up for benefits, start paying off student loans and credit card debt.
Unfortunately, the company he works for doesn't allow employees to participate at all in the 401(k) plan until they've been there a year. While this is not ideal, there are still opportunities to start saving for retirement. My brother has agreed that he can make $300 contributions to an IRA each month, so we've been in the process of determining which type is right for him (Roth or traditional), as well as where to open it.
Right now, we're leaning towards the Roth IRA for two reasons...
1. His income this year (and therefore his tax rate) is very low. It is to his benefit to put after-tax money away since I doubt his tax rate will ever be lower, he also wouldn't gain much from the tax-deduction of the traditional.
2. Next year he will get to start putting money in the 401(k), which makes him ineligible for the tax-deduction on a traditional IRA, so he will be using the Roth IRA beginning next year. It is simpler to keep making contributions to the same account, rather than trying to manage two accounts, one being very small.
Since he's been working full time for less than half the year, his income this year should be low enough that he qualifies for the Saver's Credit (google it, there's lots of good info). There are various credit levels (10% to 50%), and my estimates are that he will get a credit equal to 10% of his contributions (you can look at it as a match from the Federal Government). I've also done some playing around with estimating his tax bill for the year, and I think he'll get a nice refund, so that might play into how much he can contribute to the IRA.
5 comments:
I wish we had such a savings scheme in australia, to stimulate more saving.
I just double checked the IRS web site and your brother CAN CONTRIBUTE TO A REGULAR IRA AND TAKE THE FULL TAX DEDUCTION AS LONG AS HIS MODIFIED ADJUSTED GROSS INCOME IS LESS THAN 50K A YEAR. It sounds like that is the case with him. The Roth IRA may be a better choice for him, but I wanted to clear up this important bit of mis-information.
Next year he will get to start putting money in the 401(k), which makes him ineligible for the tax-deduction on a traditional IRA
WRONG! WRONG! WRONG! Your brother IS eligible for a traditional IRA and a 401K AS LONG AS HIS MODIFIED ADJUSTED GROSS INCOME IS LESS THAN 50K A YEAR. It sounds like that is the case. A Roth IRA may still be the better choice, but I visited the IRS web site to double check and clear up this important bit of mis-information.
Here's the info. from the IRS web site:
Table 1-2. Effect of Modified AGI 1 on Deduction If You Are Covered by a Retirement Plan at Work
If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.
IF your filing
status is ... AND your modified adjusted gross income (modified AGI)
is ... THEN you can take ...
single or
head of household $50,000 or less a full deduction.
more than $50,000
but less than $60,000 a partial deduction.
$60,000 or more no deduction.
married filing jointly or
qualifying widow(er) $70,000 or less a full deduction.
more than $70,000
but less than $80,000 a partial deduction.
$80,000 or more no deduction.
married filing separately 2 less than $10,000 a partial deduction.
$10,000 or more no deduction.
1 Modified AGI (adjusted gross income). See Modified adjusted
Here's the link if you want to read the whole thing:
http://www.irs.gov/publications/p590/ch01.html#d0e1703
Sorry if I wasn't clear, but next year he most likely won't be eligible for a tax deductible traditional IRA (at least not the full deduction), so a Roth does make more sense for him.
Steve - what about superannuation?
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