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Whew. We finally finished our taxes. I'd like to THANK everybody on this board who helped me with all my questions. As it turned out, my husband had enough withheld, and we had so many deductions that I didn't have to kick in as much money as I thought.

Which left me with a huge chunk of change in my savings account, which in turn ended up being our joint tax refund. So my husband is happy. I'm happy. He never thought about the fact that I was socking away all this cash throughout the year to pay taxes, so that even though we wouldn't get any money back from Uncle Sam, we will get a refund (except I've been earning interest).

So now our discussions have shifted to what to do with that money. I suggested taking $3500 and funding my 2004 ROTH. We haven't decided what to do with the rest of it -- maybe we'll go to the Falklands this winter to play with penguins.

DH asked me why don't I set up an SEP. My thoughts were I could do that for 2005, but I think a ROTH is a better place to put the money because a) we've already done the return and b) it will grow tax deferred and c) I can take it out in five years w/o a penalty if I want and d) it's such a small amount.

I mean, given a choice, what do you think is better? I think a self employed person should do both, but fund the ROTH first. So even for 2005, I would fund my ROTH first, then put the rest of the money into a SEP. DH thinks I should do the SEP now for 2004. Shouldn't most self employed individuals always fund a ROTH first?

Am I thinking clearly on this or am I missing something?

elizabeth
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I mean, given a choice, what do you think is better? I think a self employed person should do both, but fund the ROTH first. So even for 2005, I would fund my ROTH first, then put the rest of the money into a SEP. DH thinks I should do the SEP now for 2004. Shouldn't most self employed individuals always fund a ROTH first?

Am I thinking clearly on this or am I missing something?


You're missing something. I don't think you fully understand what a SEP-IRA is. It is an ordinary IRA with an extra bonus... you get to contribute a percentage of your net self-employment income. Every dollar you contribute from your profit reduces your taxable income and self-employment taxes. So...I would make the employer-side SEP contribution AND make the employee-side contribution (3000/3500 in 2004) as well. The only difference is that the employee-side contribution goes directly to the Roth IRA. If your AGI is low enough, you might consider converting the employer-side contribution to a Roth IRA as well.

Note, if you move both sides of the SEP-IRA contribution to the Roth IRA, you won't be saving anything on income taxes, but you might still be saving some SE tax.

Ira
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So...I would make the employer-side SEP contribution AND make the employee-side contribution (3000/3500 in 2004) as well.

So you think the deduction from taxable income is more important than tax-deferred income? Is that what you're saying? Perhaps it would help you if I told you I'm turning 53 in a few months. Does this make a difference?

I would think funding a tax-deferred ROTH would be more important (*paying the taxes now on $3,500) and funding the SEP from my income secondary (deducting the LARGER SUM OF EARNED INCOME) would make more sense.

So . . . now what am I missing?

elizabeth
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Every dollar you contribute from your profit reduces your taxable income and self-employment taxes.

Ira, are you sure about this? I have never seen a change in my net SE income or SE tax when I pay into my SEP. It is an adjustment to income on pg 1 of the 1040, not the Sch C. If my SE tax is supposed to go down, I have some amended returns to work on.

SA
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elizabeth,

Conventional wisdom says fund the Roth if you expect to be in a higher tax bracket in retirement, fund the SEP and regular IRA if you expect to be in a lower tax bracket. Of course, who knows what the tax brackets will be when we retire, right?

Personally, I fund my SEP first. I am a firm believer of a bird in the hand, when it comes to the gov't and taxes. I'll take my deduction now, thank you very much. I have no confidence that Roths will remain tax-free and Congress won't go messing that up too. And this is despite the fact that I have good reason to believe that our income will be much higher in retirement than it is now.

On the other hand, I think most people believe that taxes will only go up, and therefore choose the Roth now for it's tax-free status later.

It really depends on what you're most comfortable with. Have you run the numbers to see how much of a tax break you'd get today by opening a SEP? That might make a difference in the decision.

SA
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Greetings, elizabeth, do I remember correctly that your 2005 earnings are closer to $200K than $100K? Are you and your husband filing jointly? I have a sense that your adjusted gross income may exceed the Roth ceiling for eligibility for contributions. Others here could share in more detail what the income ceiling is.

xraymd
sometimes this could be seen as a nice problem to have!
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Every dollar you contribute from your profit reduces your taxable income and self-employment taxes.

Ira, are you sure about this? I have never seen a change in my net SE income or SE tax when I pay into my SEP. It is an adjustment to income on pg 1 of the 1040, not the Sch C. If my SE tax is supposed to go down, I have some amended returns to work on.


You're right. Case of putting fingers in gear before brain.

Ira
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So...I would make the employer-side SEP contribution AND make the employee-side contribution (3000/3500 in 2004) as well.

So you think the deduction from taxable income is more important than tax-deferred income? Is that what you're saying? Perhaps it would help you if I told you I'm turning 53 in a few months. Does this make a difference?


No, I think both are important. The employer-side SEP contribution creates tax-defered income -- that's what an IRA is...a vehicle for tax deferred growth. It also saves on immediate taxes. For what its worth, I have SE clients in their 70's who are still making SEP-IRA contributions (employer-side) and Roth IRA contributions (employee-side) while taking their MRDs at the same time.

On the other hand, if you qualify and can afford to pay the tax associated with converting the employer-side contribution to a Roth IRA immediately, you can create a substantial tax-free income generator.

I would think funding a tax-deferred ROTH would be more important (*paying the taxes now on $3,500) and funding the SEP from my income secondary (deducting the LARGER SUM OF EARNED INCOME) would make more sense.

Roth IRAs are not tax-deferred, they are tax-free. Ordinary IRAs are tax-deferred. You really should run the numbers. If your SE income is high enough, the tax savings on the SEP-IRA contribution could fund the Roth IRA contribution.

Ira



So . . . now what am I missing?
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You really should run the numbers. If your SE income is high enough, the tax savings on the SEP-IRA contribution could fund the Roth IRA contribution.


Ah . . . the light bulb is going on. Thank you, Ira. I never thought about this aspect. Very interesting!

To address xraymd's question, is $150,000 the maximum joint income my husband and I can earn so I can fund a ROTH, or is my income that can't exceed $150,000? Because that would be a potential problem for 2005.

elizabeth
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is $150,000 the maximum joint income my husband and I can earn so I can fund a ROTH, or is my income that can't exceed $150,000?

It is your joint AGI. If you're between 150k and 160k you get a partial Roth contribution. Over 160k and its no Roth at all.

--Peter
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It is your joint AGI. If you're between 150k and 160k you get a partial Roth contribution. Over 160k and its no Roth at all.
--Peter

 


So, if our joint income is below $150K this year but will exceed that amount next year, then it makes sense to do a ROTH for 2004 becuase I won't even be allowed to do that next year, right? I mean, assuming that the monies I put into a SEP will not lower our joint income to $150, right?

elizabeth
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So, if our joint income is below $150K this year but will exceed that amount next year, then it makes sense to do a ROTH for 2004 becuase I won't even be allowed to do that next year, right?

Maybe. Conventional wisdom is to use a Roth when you expect your retirement income to be higher than your current income, and to use a traditional IRA when your current income (or more correctly your current tax rate) is expected to be higher than in retirement.

If you're flirting with the Roth limits, your tax rate is likely fairly high now. That would make a traditional IRA the usual favorite. But if a Roth makes more sense for you, then yes, this would be an opportunity to make a Roth contribution.

I mean, assuming that the monies I put into a SEP will not lower our joint income to $150, right?

I can never remember if a SEP is an allowable deduction in calculating your MAGI for Roth purposes. Perhaps someone else can confirm. If it is, then if you want a Roth, a reasonable strategy might be to make a SEP contribution to get your MAGI down to where you can make a Roth contribution.
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