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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121482  
Subject: Student Trying to Game the System Date: 2/8/2006 5:38 PM
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This will be a little long, but if you bear with me....

I'm wondering about the possible tax implications of rolling over a regular IRA into a Roth IRA and how i can do this the most efficiently (i.e. with out losing money to taxes). Right now this is my situation.
I am young (24) and am about to start law school in September. I have been making some decent money as a paralegal and have:
11,000+ in a Regular IRA (with my 2006 contribution already)
plus I have around 7,000 in a 401k at work (probably 9-10 thou when I quit work in late may.
The thing is, although I knew that I should probably have been putting the IRA money into a Roth when I first started, but I figured I would take the deduction now, and then when I was in law school with no income I would roll it over into a Roth (since the IRS says you have to pay tax on the money you roll over at the income level you are at when you roll over). In my mind I was gaming the system, taking the deduciotn now, then rolling it over when I was in law school, paying taxes at almost no income, and getting any taxes I paid back anyway with the lifetime learning credit ($2,000). BUT....
I suggested this strategy to my GF, who is doing the same thing re: med school. But this year, she only made about $9,500 (half the year at NIH so paid with taxable grants). Then this year, when we were doing taxes together, her tax went up when she entered in the money she had put into an IRA (by $200!) which sucked. But I thought that happened because of the rules that you have to make a certain amount of money to put money into a IRA?
So the questions I have are:
1) Should I roll over my 401 k money to a NEW Roth IRA this year?
I can probably avoid most taxes since Im only working half the year, plus I will get the lifetime learning credit as well.
2) Should I roll over the 401 k into the old IRA (paying no taxes this year). Then next year, while in law school with almost no income (maybe 10,000 for summer associate position) I will roll the entire IRA into a Roth (20,000 total). Or will I have a big tax liability because im not working and earning enough?
3) Should I roll over the 401k to the regular IRA, leave everything in the IRA and then try and roll it over the first year out of law school (hopefully clerking and not making so much that I am forbidden from opening a Roth)?

My thoughts from reading before my girlfriends experience with her taxes this year was to try the number 2 option. But now I am thinking that perhaps I want to try the number 1 option?

Thanks to anyone who actually read the whole thing :)
-jesse
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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83691 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 5:41 PM
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Just to be clear... when I say roll over from regular IRA to Roth I mean convert.... and the conversion taxes are what Im trying to "mitigate"
-Jesse

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83694 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 6:43 PM
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Then this year, when we were doing taxes together, her tax went up when she entered in the money she had put into an IRA (by $200!)

When doing taxes in a taxprep program, ignore the constantly-updating figure. It's worthless.

You are only allowed to contribute to a Roth IRA if you have sufficient W-2 or self-employment income (but not too much mAGI).

You are allowed to convert a Traditional IRA to a Roth IRA if your mAGI is below the limit.

You can't roll over a 401(k) into a Roth IRA. It has to go into a Traditional IRA first. Then you can convert to a Roth IRA.

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Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83695 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 6:59 PM
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I'm wondering about the possible tax implications of rolling over a regular IRA into a Roth IRA and how i can do this the most efficiently (i.e. with out losing money to taxes).

If you have any kind of financial aid, you might want to concerned about the implications of this strategy(converting anything to a Roth) on your package for the following year.

rad

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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83696 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 7:08 PM
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As jrr said, you have to roll the 401K into an IRA first. Then you can convert it to a Roth IRA.

I would do it next year (well, roll to a traditional IRA whenever you want, that's not a taxable event, although you'll probably have to wait to stop working).

I don't see why you'd do #3. Do it in the year when you have the least income so you pay the least in taxes.

One thing to think about... if you guys have any plans for marriage... if you get married Dec 31st, 2007, you're considered marriage for all of 2007 for tax purposes. So if your GF will have income in 2007, and you'll be married in 2007 for tax purposes, then that could throw off your plans.


The thing is, although I knew that I should probably have been putting the IRA money into a Roth when I first started, but I figured I would take the deduction now, and then when I was in law school with no income I would roll it over into a Roth (since the IRS says you have to pay tax on the money you roll over at the income level you are at when you roll over).

If you could have done both, there was no reason not to. But if not, you certainly went the right way. This way you're set up for money that's tax free for all time (or pretty close to it if you have to pay a little in rollover taxes).


I suggested this strategy to my GF, who is doing the same thing re: med school. But this year, she only made about $9,500 (half the year at NIH so paid with taxable grants). Then this year, when we were doing taxes together, her tax went up when she entered in the money she had put into an IRA (by $200!) which sucked.

Hmmmm? Are you saying she rolled over this year? If so, what percentage of the rollover amount is $200? If she rolled over much more than $1K, seems to me she got away pretty well.

Or are you saying she got taxed on her contributions to an IRA? If so, no way that's possible. Make sure she didn't enter her rollover as a contribution. And that her contribution wasn't more than $4000, and wasn't more than her earned income.

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83705 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 7:51 PM
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Your general plan is good. Convert money from a traditional IRA to a Roth in a year with little or no other income, and you'll pay little or no tax on the conversion. Nothing at all wrong with your plan. In fact, I've done exactly that myself.

I concur with the thoughts on financial aid. I don't know the details, but I'd find out how a Roth conversion affects your aid before doing the conversion. Perhaps converting in your last year of school, when financial aid in the following year is not an issue might be a way to deal with that if absolutely necessary. Or converting less than all of your accout - just enough to keep under whatever financial aid limits may be the concern.

If you can swing it, I'd absolutely do this with the 401k money as well. No sense in letting the annual personal exemption and standard deduction go unused.

--Peter

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Author: sailrmac Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83707 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 8:18 PM
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Thanks for your post.  
It made me think this might be a good idea for me.
So I put together a spreadsheet to analyze my situation.
You might want to do the same.

The $59,400 is the point where you cross into the 25% tax bracket.
In my case it makes sense to convert until I have an AGI of $59,400
but not any further.
Obviously your age and assumed ROI will make a big difference.

Here is what I came up with; hopefully it will help you do the samefor yourself.

	AGI	$59,400		
	Potential Tax	$8,180		
	Assumed ROI	8%		
	Est. Future Tax Rate	19.4%		



Age	Convert	    Withdrawal  Keep	  Net Withdrawal
40	$51,220		        $59,400	
41	$55,318		        $64,152	
42	$59,743		        $69,284	
43	$64,522		        $74,827	
44	$69,684		        $80,813	
45	$75,259		        $87,278	
46	$81,280		        $94,260	
47	$87,782		        $101,801	
48	$94,805		        $109,945	
49	$102,389		$118,741	
50	$110,580		$128,240	
51	$119,427		$138,499	
52	$128,981		$149,579	
53	$139,299		$161,546	
54	$150,443		$174,469	
55	$162,479		$188,427	
56	$175,477		$203,501	
57	$189,515		$219,781	
58	$204,676		$237,364	
59	$221,050		$256,353	
60	$238,734	$16,823	$276,861	$15,719
61	$241,010	$17,327	$279,500	$16,190
62	$242,964	$17,847	$281,766	$16,676
63	$244,553	$18,383	$283,609	$17,176
64	$245,735	$18,934	$284,980	$17,691
65	$246,460	$19,502	$285,820	$18,222
66	$246,674	$20,087	$286,069	$18,769
67	$246,321	$20,690	$285,659	$19,332
68	$245,337	$21,311	$284,518	$19,912
69	$243,653	$21,950	$282,565	$20,509
70	$241,195	$22,608	$279,715	$21,124
71	$237,883	$23,287	$275,873	$21,758
72	$233,627	$23,985	$270,938	$22,411
73	$228,332	$24,705	$264,797	$23,083
74	$221,893	$25,446	$257,330	$23,776
75	$214,199	$26,209	$248,407	$24,489
76	$205,125	$26,996	$237,885	$25,224
77	$194,540	$27,805	$225,609	$25,980
78	$182,298	$28,640	$211,411	$26,760
79	$168,242	$29,499	$195,111	$27,563
80	$152,202	$30,384	$176,510	$28,389
81	$133,995	$31,295	$155,394	$29,241
82	$113,419	$32,234	$131,533	$30,118
83	$90,259	        $33,201	$104,673	$31,022
84	$64,278	        $34,197	$74,543	        $31,953
85	$35,223	        $35,223	$40,848	        $32,911
86	$0		        $0	


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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83708 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 8:31 PM
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Thanks for your post.
It made me think this might be a good idea for me.
So I put together a spreadsheet to analyze my situation.
You might want to do the same.

The $59,400 is the point where you cross into the 25% tax bracket.
In my case it makes sense to convert until I have an AGI of $59,400
but not any further.


Wrong. $59,400 in TAXABLE income, not AGI, is the crossover. Include your standard deduction ($10000) and two exemptions ($6400) for MFJ and your AGI can be $75,800 before you enter the 25% bracket.

Ira

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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83709 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 8:38 PM
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"If you have any kind of financial aid, you might want to concerned about the implications of this strategy(converting anything to a Roth) on your package for the following year." <italics>


Why would my conversion count against my financial aid package? Because I would report it as income on my taxes? Ive never done a conversion so I don't know what the tax strategy would be like, but I was assuming it would be some kind of 1099 form that I would fill out. I wouldnt imagine that would count against me for financial aid... which I am definitely going to be applying for.
-On that topic, do you happen to know if Fin Aid people will hold large retirement accounts against me?
I would hope not, but who knows with those people.
-Jesse
Thanks for the response




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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83710 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 8:41 PM
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The GF would be in med school for one more year than I would, so she would have no income at all, so we would be in a decent position tax wise I think. But point taken, definitely.

No, she didnt roll over this year, she just took some money that she had saved in other accounts and opened an IRA this year under my suggestion, but as JRR said, I should ignore the constantly updating figure in the top of the Turbo Tax. (I had read that before but always forget).

Thanks for all the help.

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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83711 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 9:09 PM
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Its worth printing out and looking over your tax return before you send it in, just to make sure the program took what you told it the way you wanted it to. But yeah, that's still not possible :)

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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83715 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 9:48 PM
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"If you have any kind of financial aid, you might want to concerned about the implications of this strategy(converting anything to a Roth) on your package for the following year." <italics>


Why would my conversion count against my financial aid package? Because I would report it as income on my taxes? Ive never done a conversion so I don't know what the tax strategy would be like, but I was assuming it would be some kind of 1099 form that I would fill out. I wouldnt imagine that would count against me for financial aid... which I am definitely going to be applying for.
-On that topic, do you happen to know if Fin Aid people will hold large retirement accounts against me?
I would hope not, but who knows with those people.


They won't look at your retirement assets, but they do ask for your AGI. Your conversion shows in your AGI. They don't care that you converted the traditional IRA to a Roth IRA. As far as they're concerned, you "could" have used those funds to pay for education. So, you would be wise to take the advice of a previous poster and wait until the last year of education, when you'll no longer be applying for aid.

Ira


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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83718 of 121482
Subject: Re: Student Trying to Game the System Date: 2/8/2006 10:09 PM
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No, [GF] didnt roll over this year, she just took some money that she had saved in other accounts and opened an IRA this year under my suggestion, but as JRR said, I should ignore the constantly updating figure in the top of the Turbo Tax. (I had read that before but always forget).

It seems there's something else you've forgotten. In order to make IRA contributions, which is what she did, one must have "taxable compensation." IOW, wages or income from self-employment (lines 7 and 12 of the 1040). Piecing together bits from various eariler posts in the thread I'm concluding that she didn't have sufficient taxable compensation for her IRA contributions, and you'll find an additional tax of 6% of the IRA contribution in the "Other Taxes" portion of page 2 of her 1040.

If that's the case, she must withdraw the contributions and earnings on them before the due date of her return. Otherwise she owes the penalty, and will continue to owe another 6% each year until she withdraws the excess contribution or has enough earned income in a future year to allow it.

See Publication 590.

Phil


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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83723 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 9:49 AM
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"one must have "taxable compensation"

That was the problem, I knew she had taxable compensation, but I didnt know how she would get paid. And she ended up getting her tax form on a 1099-G instead of a w-2 (and as 590 says, she must have her fellowship paid through a w-2).
What a bummer. I didnt know that I could take the money back out though and then not have to pay the penalty. Thanks for all the help.
-Jesse

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83725 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 9:59 AM
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I didnt know that I could take the money back out though and then not have to pay the penalty.

Your choices are:
1. Take out the money and pay the income tax and early withdrawal penalty on the earnings, or
2. Leave it in there, pay the 6% on the contributions, and this year don't contribute as much.

Unless your investments went gangbusters, #1 is a better choice.

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Author: GumNaam Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83727 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 10:38 AM
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11,000+ in a Regular IRA (with my 2006 contribution already)
plus I have around 7,000 in a 401k at work (probably 9-10 thou when I quit work in late may. The thing is, although I knew that I should probably have been putting the IRA money into a Roth when I first started, but I figured I would take the deduction now,


It seems you have been deducting traditional IRA contributions from taxable income while contributing to a 401(k) plan at work. I don't think that's allowed. AFAIK, if you are even eligible for a 401(k) plan, you cannot make deductible contributions to a traditional IRA.

but I didnt know how she would get paid. And she ended up getting her tax form on a 1099-G instead of a w-2

AFAIK, 1099-G monies don't count as earned income.

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83729 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 12:46 PM
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jessedungan:

<<<"If you have any kind of financial aid, you might want to concerned about the implications of this strategy(converting anything to a Roth) on your package for the following year.">>>

"Why would my conversion count against my financial aid package? Because I would report it as income on my taxes?"

YES. YES.

"I've never done a conversion so I don't know what the tax strategy would be like, but I was assuming it would be some kind of 1099 form that I would fill out. I wouldnt imagine that would count against me for financial aid..."

Wrong. The FAFSA form will want to know your income. And the conversion amount will be income.

I have no idea how retirement accounts of the student are considered on the FAFSA.

Regards, JAFO




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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83730 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 12:56 PM
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"You will need the following information to complete this Worksheet (FAFSA):

- 2005 federal tax information or tax returns (including IRS W-2 information) for yourself and spouse if you are married, and for your parents if you are providing parent information. If you have not yet filed a 2005 income tax return, you can still submit your FAFSA but you must provide income and tax information.

- Records of untaxed income, such as Social Security benefits, welfare benefits (e.g., TANF), and veterans benefits, for yourself, and your parents if you are providing parent information; and

- Information on savings, investments, and business and farm assets for yourself, and your parents if you are providing parent information."

http://www.fafsa.ed.gov/fafsaws67c.pdf

"What was your (and your spouse's) adjusted gross income for 2005? Adjusted gross income is on IRS Form 1040—line 37; 1040A—line 21; or 1040EZ—line 4."

Id.

"As of today, what is your (and your spouse's) total current balance of cash, savings and checking accounts?

As of today, what is the net worth of your (and your spouse's) investments, including real estate (not your home)? Net worth means current value minus debt.

-----

- Investments include real estate (do not include the home you live in), trust funds, money market funds, mutual funds, certificates of deposit, stocks, stock options, bonds, other securities, Coverdell savings accounts, college savings plans, installment and land sale contracts (including mortgages held), commodities, etc. Investment value includes the market value of these investments as of today. Investment debt means only those debts that are related to the investments.

- Investments do not include the home you live in; the value of life insurance, retirement plans (pension funds, annuities,
noneducation IRAs, Keogh plans, etc.), and prepaid tuition plans; or cash, savings, and checking accounts."

Id.

FAFSA apparently still excludes retirement accounts. If you attend a private school, it may or may not use the same methodology.

Regards, JAFO




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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83731 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 2:06 PM
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It seems you have been deducting traditional IRA contributions from taxable income while contributing to a 401(k) plan at work. I don't think that's allowed. AFAIK, if you are even eligible for a 401(k) plan, you cannot make deductible contributions to a traditional IRA.

No. Being eligible for a retirement plan at work just makes the mAGI thresholds for deductibility lower. If your income is low enough, you can still deduct Traditional IRA money.

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Author: GumNaam Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83735 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 3:06 PM
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AFAIK, if you are even eligible for a 401(k) plan, you cannot make deductible contributions to a traditional IRA.

No. Being eligible for a retirement plan at work just makes the mAGI thresholds for deductibility lower. If your income is low enough, you can still deduct Traditional IRA money.


Now I know better. $50,000 to $60,000 for single or head of household filers according to http://www.fool.com/ira/ira02.htm

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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83742 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 4:44 PM
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I did try to look into some of my fineagling before i started - Ha Ha

"No. Being eligible for a retirement plan at work just makes the mAGI thresholds for deductibility lower. If your income is low enough, you can still deduct Traditional IRA money."

And in my case i wasnt able to deduct it all, but was able to contribute and now will simply carry a cost basis forward for the remainder of the contribution that was not deductible.


but good points all, the investments have not gone gangbusters so the penalty will definitely be the best case scenario....
IM just still frustrated that she got paid through a 1099-G instead of fellowship income that was reported via a w-2 form, but se la vie.
-


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Author: jessedungan Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83762 of 121482
Subject: Re: Student Trying to Game the System Date: 2/9/2006 10:00 PM
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jrr7...
Im trying to understand why you think that number 1 is cleary the best answer. I was talking it over with my girlfriend and she said, "well as long as my accounts average over 6% earnings im in pretty good shape"
And i thought, well...that makes sense somewhat
And i ran the numbers on excel and according to the calculations, if she were to get the average 10% gain on her investments, even paying the penalty EACH year (since she is about to go to med school she might not have a w-2 for four years) she will come out ahead about 387 dollars
(I ran the math in excel and would be glad to send you the spreadsheet if you wanted) but this is what it looks like
NB: I started with 2500 because she did have a w2 form from one job where she made 500 dollars

10%
w/ penalty
2500 2750 2585
2585 2835 2664.9
2664.9 2914.9 2740.00
2740.06 2990.06 2810.60
2810.60 3060.64 2876.96


So that to me suggests that we should simply leave the money in there and hope for the best. even if it only makes 2% i calculated that she only loses 500 dollars in 5 years. I guess versus keeping it in cash (Fin Aid might just take it all) it would be preferable even losing the 500 rather than the 2500
if anyone has any other ideas I would welcome them
thanks again


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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83802 of 121482
Subject: Re: Student Trying to Game the System Date: 2/10/2006 5:26 PM
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And in my case i wasnt able to deduct it all, but was able to contribute and now will simply carry a cost basis forward for the remainder of the contribution that was not deductible.

I think you may have to file a form to report the nondeductible portion.

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 83805 of 121482
Subject: Re: Student Trying to Game the System Date: 2/10/2006 6:12 PM
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I can't figure out your table.

If you assume 10% gains, all taxable, then the clear thing to do is leave it in the IRA and pay the penalty until she's eligible to contribute.

However most of the time your gains are mostly long-term-capital-gains and a little bit of STCG (or STCL) and income.

In those cases the calculation is much closer.

And if you lose money....

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