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Author: BladeXrunners One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121597  
Subject: Re: marriage, IRAs, confusion Date: 10/19/1999 5:28 PM
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In the two years we've been married, my husband and I have chosen "married, filing separately status" mainly because I make less, deduct more,

I'm surprised that you're filing MFS. One usually pay more combined tax MFS than MFJ. Remember, when filing MFS, either you both use the standard deduction or you both itemize. In other word, you can't itemize while your spouse take the standard deduction: see IRS Publication 501 Exemptions, Standard Deduction, and Filing Information). The only situation where MFS would be beneficial is 1) both spouse make the same, 2) when one have a lot of one type of deduction (e.g. medical) and the other doesn't; thus, by filing MFS, one can take advantage of the floor for the deduction. Again, this situation is rare. For most, MFJ is the best.

I don't know your exact situation, so can't comment on whether it's to your benefit to file MFS or MFJ (to be sure, do both and compare the "combined" tax). But let's look at an example: let's say you make $20,000 with $8,000 in deduction and you're spouse make $70,000 with $1,000 in deduction. The combined tax liability for MFS, itemized is $17,566; MFS, standard $17,420; & MFJ, itemized $15543.50. Again, for most couple, the most beneficial is MFJ.

and enjoy a nice refund.

Having a nice refund only means that the withholding is incorrect. Most likely, because you're making less, you filed 0 allowance on your W4, thus had too much tax withheld. To ensure your withholding is correct, do the W4 together (i.e., use your combined income and combined deduction, etc.) This will give the total number of allowances the both of you should claim. Then, divide the number of allowances any way you want. For example, if after doing the combined W4, the number of allowances is 5, then you can claim 0 and your spouse claim 5, or you can claim 2 and your spouse claim 3, etc. Remember, having a refund means you had lost money due to lost interest earned on the refund.

I'm now looking into starting an IRA and have found that it's nearly impossible to make contributions to a Roth IRA while claiming "married, filing separately" status.Are the benefits of the Roth IRA compelling enough in the longrun that we should just start filing jointly?

First, I'll explain the pro and con of the traditional IRA & the ROTH IRA. For full detail, see IRS Publication 590 Individual Retirement Arrangement.

Traditional IRA:
Pro: contribution may be deductable. If you are not covered by your employer's retirement plan and you file MFJ, then all of the contributions (up to the annual limit) are deductable. If you file MFS or if you are covered by an employer's retirement plan, then the deduction get phase out. For MFS, it get phase out if you earn more than $0 (i.e., it get phase out immediately.).
Con: you get charged a 10% penalty for "early withdrawal". Early withdrawal are withdrawal made before you are 59 1/2. Also, all withdrawal are taxed.

ROTH IRA:
Pro: Withdrawal may be tax-free if you meet certain condition. 1) Have the account opened for at least 5 years and either a) made on or after you reach 59 1/2, b) made because you are disabled, c) made to a beneficiary or to your estate after your death, or c) meet first time home requirement ($10,000 lifetime limit).
Con: Contribution are not deductable. If the withdrawal don't meet the above condition, then it is taxed and subject to a 10% early withdrawal penalty.

To answer your question, you should only contribute money earmarked for retirement. For example, if you need those money in 2 years, don't put it in an IRA. If the money is earmarked for retirement, then you have to calculate if it is deductable. Whether you put the money in a traditional IRA or a ROTH IRA depend on if it is deductable.

If it is deductable, I would put it into the traditional IRA. Why? because it's pre-tax, so you can put more in. For example, if your marginal federal tax rate is 28% and your state is 9.3%, then for every $1000 you put in a traditional IRA, you can only put $627 in the ROTH IRA. The "tax-free" aspect of the ROTH IRA is balanced out by the fact that you can put more money into the traditional IRA. So, although you pay tax on the traditional IRA, you have much more money earned there, so your net is the same as the ROTH. (The second reason why I prefer traditional IRA over the ROTH IRA is that congress can and will change its mind. It is possible that they will tax the ROTH IRA later. Not as impossible as you think. The original social security is the same as a forced ROTH IRA--contribution is after-tax, distribution is tax-free. But then, congress decided that they don't have enough money in their tax coffer, so they enacted a law to tax your social security distribution within some limits. Same can happen to the ROTH).

If your contribution is not deductable, then put it in the ROTH IRA.

The benefit of the IRA account in the long-run is tremendous. For example, $10,000 invested in an IRA account (doesn't matter if it's a traditional IRA or a ROTH IRA) may become $181,000 whereas the same amount outside the IRA may become only $63,000 (assuming same rate of return for both IRA & non-IRA). So it is to your benefit to max out your IRA. (As for your filing status, it's also to your benefit to file jointly).
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