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Traditional IRA: Saving Broke Millennials Hundreds of Dollars

   Posted On: March 5, 2014  |    Posted In: Millennials  |     Posted by: Broke Millennial®

Uncle Sam
Admit it, we’re all thinking “I Want Your Money.”

A week ago I sat down at my computer to do my duty as a patriotic, slightly irritated, American and file my taxes. Filing my taxes always leaves me feeling a little like Oliver Twist begging for more. My first experience with income tax occurred in college — while my parents still lived overseas — so I didn’t even have parental guidance to lean on. I picked up the paper forms from the campus post office and proceeded to pull my hair out for several hours whilst trying to figure out what all the boxes and numbers meant. I couldn’t tell you if I got much back, it would’ve probably been in the ballpark of $150, but the experience left me admiring those who understand tax code and know how to find loop holes.

Five years later and I’m still searching for ways to keep my hard-earned dollars away from the clutches of Uncle Sam, all while doing my own taxes of course.

This year, I finally did something I should’ve done long ago that made the difference between owing my State and Country nearly $650 verse having them pay me just over $800. What happened this year you ask?

I fully funded a traditional IRA.


Overwhelming, the advice is for young investors to throw their excess cash towards a Roth IRA. I’m down with Roth. In fact, my 401(k) is a Roth account, but that does diddly-squat (self-five for using that term) when it comes to helping with taxes. Why, you ask? Well, let’s break down the difference quickly.

Roth pay taxes now. Traditional pay taxes later.

Okay, that’s the most simplified version possible, but it’s the most relevant factor when it comes to utilizing an IRA to get a tax break.

If you fund a Roth IRA then your contributions aren’t tax deductible, so it doesn’t lower your taxable income. The upside is that you aren’t taxed when you start making withdraws after you turn 59 ½ . Roth accounts are often viewed as a win in the long-term, however, I needed a win in the short-term.

I don’t want to owe money

For the first time I was looking at owing money to New York State and the Federal Government. Frankly, it was a bit asinine in my opinion. I already make less than $40,000 a year, which I pay taxes on all year (perhaps I should be waiting to owe taxes at the end of the year but that’s an entirely separate post). I had less than $2,000 of income in a 1099-MISC from freelance work and made a paltry sum in dividends from a mutual fund. But because of my freelance work, I was looking at owing over $600 (according to that fun little ticker on the left-hand side of TurboTax)?

Fortunately, I’d anticipated owing which is why I’d a) already saved up spare cash just in case I did have to cut a check to Uncle Sam and b) investigated my options for lowering my taxable income.

Even though I contribute to a retirement plan at work, I am legally allowed to fully contribute to an IRA because I’m a single individual with a modified AGI of $59,000 (in 2013, it will be $60,000 in 2014).

In order to drop my taxable income by $5,500 — which I fortunately had access to without killing my emergency fund — I went to Vanguard [nope, not a referral link].  Even though this act transpired in 2014, it counts for my 2013 taxes because you can fully fund an IRA for 2013 until April 15.

The process of setting up my IRA took all of an hour and it took that long because I put a little more research into picking my funds than the average millennial and called up a representative at Vanguard to answer a few questions. An hour well-spent because it made the difference between owing money and receiving a tax refund.

This method isn’t magic for all

The method to my tax-filing-madness certainly isn’t for everyone. If you don’t have the funds to contribute to both a Roth and traditional accounts then you should seriously consider which will serve you better in the long-run.* While I’ve always favored Roth, Matt Becker over at Mom and Dad Money has an excellent breakdown of why Roth isn’t always the best for young investors.

It also isn’t a legal tactic for everyone depending on your level of income and whether you (and/or a spouse) contributes to a retirement plan through work.

For those who are with me on the lower-end of the income spectrum and who also happen to be diligent savers with some money saved up, then going the traditional IRA track might be right for you. Or, if you’re like me then you might be running a very long experiment about which investment was indeed better: Roth or Traditional? We can discuss the results in 35 years!

Did you open a traditional IRA for tax purposes? What legal loopholes have you found?

[Uncle Sam image taken from DonkeyHotey on Flickr. Gif taken from GIPHY]

*As a point of clarification, I was referring to contributing to a company retirement plan and a separate IRA. I personally have a Roth 401(k), so I’m contributing to both Roth and traditional funds. You can’t fully fund two separate IRAs each tax season. Thanks for asking for clarification, Mr. DonebyForty!

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30 responses to “Traditional IRA: Saving Broke Millennials Hundreds of Dollars

  1. I’ve always favored a Roth IRA as well, simply because I KNOW what my financial situation is now and I can’t know with absolute certainty what it will look like when I’m ready to retire. Therefore, I’d rather deal with the mess that is taxes on that money now and not have to worry about it when I’m withdrawing my money to live off of in the future. But after owing about $1k in taxes this year, I’m definitely tempted to dedicate more money to an account where, like you said, it gives me a win now! I’ll probably stick with my Roth for as long as I have an employer, but if I do go full-time with my side business and stop receiving that reliable, regular paycheck, I’m already planning on switching to something that’s tax-deferred – with a variable income I think a win now becomes more important.

    1. I 100% agree with your strategy. Like I mentioned in the article, I went with Roth via my employer and see a lot of value in the Roth. But it just made sense for me to open traditional this year, plus it does add diversification to my retirement funds.

  2. After reading a lot on this topic I’ve decided that it really doesn’t matter too much if you go with a Roth or Traditional IRA. Either way you are going to pay taxes at some point and either way you are going to save money for retirement. You win and you “lose” either way, so in the end I say just flip a coin. Just kidding, but on a serious note congrats on fully funding an IRA. It’s something I’m definitely considering this year.

    1. Actually, that’s not necessarily true. I took an accounting course at a college. The guy mapped out IRA vs Roth. The Roth had significantly more money at the end. Granted, everyone’s tax situation is different, but it was enough to convince me to do the Roth.

      Personally, I’m in a Roth right now. Though, since I’m self-employed, I’m looking into a SEP, hoping it will have a Roth option.

      I plan to work for as long as possible, and my boss keeps giving me raises. So it’s a pretty fair bet that we’ll be paying more in taxes when we can start using the IRA.

    2. It depends, really, from situation to situation. The Roth will have more over time assuming you won’t be touching the money for a long time since earnings aren’t taxed and grow faster as a result.

      If you are young and don’t plan on working your whole life, the traditional IRA route and taking the SEPP rule might be better. It just depends on how long you plan on working.

      1. Hi Ricky, just a quick correction (sorry for taking over Erin). It’s actually not correct that the earnings grow faster in the Roth. Both accounts defer taxes on all money actually in the account, so it’s a wash there. And if your tax rate at the point of contribution is the same as your tax rate at the point of withdrawal then it’s actually still a wash. And keep in mind that “tax rate” there doesn’t necessarily mean marginal rate in the way that it’s commonly communicated. The analysis is more complicated than most people let on, which Erin does a good job of communicating here.

        1. Not quite a wash since every thing else being equal (amount contributed, gains, etc.) with a ROTH you don’t need to pay taxes on your earnings at all while with a Traditional you do, when the money is taken out.

          1. It actually is a wash entirely. If you stay in the same tax bracket, equivalent after tax dollars contributed to a Roth will grow to the exact same dollar amount as the deferred traditional after taxes are paid. The exact same amount.

          2. Still not a wash. You’re right in that they grow the same, but the tax implications make the amount that arrives in your hands different. Lets simplify and do the math.

            You put 1000 in both a ROTH and a traditional. In thirty years it grows to 5000 since they both grow at the same rate.

            ROTH: you are taxed on the 1000 as you earn it. Lets assume a 10 percent tax for simplicity. You hand over 100 to the gov. When you retire, you pay nothing, for a total of 100 dollars paid on 5000. You actually see 4900 of your money.

            Traditional: you don’t pay tax on your 1000 immediately. But when you retire you need to pay tax on 5000. At ten percent, you pay 500. Meaning you only get 4500 of your money.

    3. I agree with DC’s point that as long as you’re saving for retirement from a young age it’s an instant win. Roth or Traditional, you’re still utilizing compound growth from an early age which helps immensely.

  3. Like DC said, you get taxed either way. But I think you’re right, Erin, there are definitely good reasons why a young investor might want to favor a traditional IRA over a Roth. Congrats on fully funding an IRA last year!

    1. Thanks, Adam! I do think at the end of the day it’s important that people be saving for retirement whether it’s Roth or Traditional. The saving early and consistently part is really important.

  4. Nice work Erin! I tend to go with a Roth as well, but the Traditional definitely can be a good route to take, especially with resulting in not having to owe. That said, I think tax diversification is a key point to look at as well so we’ve done both. We didn’t do a Traditional, per se, but opened SEPs which act similarly.

    1. Diversification is something I didn’t really think about off the bat, but glad I almost just fell into it by having Roth and Traditional.

  5. This is something I might pull out as a last straw if I owe too much this year. Anything that will help make this year less painful. I did fully fund my Roth IRA, but can take a little bit out of my efund to send to my traditional IRA if I need to.

    1. I was glad I didn’t have to hit my efund much to fund it, but if I want to fully fund next year then I might have to skim off the top a bit. Hope you didn’t have to owe too much!

  6. I’m considering making the switch as well, Erin. It’s tough because I don’t know what tax rates will look like or what my income will be in the decades to come. So a part of me likes the fact that the Roth provides a little tax diversification.

    I had one question on this quote: “If you don’t have the funds to contribute to both a Roth and traditional account then you should seriously consider which will serve you better in the long-run.”

    I thought you could only contribute $5,500 to one (or, if doing both, then the total would be $5,500). That is, even if you have the money, I don’t think you can contribute to both…right?

    1. Thanks for the call out! I edited the article earlier to clarify what I had meant because I contribute to a Roth 401(k) and traditional IRA.

    1. I’m sure it’s unique to everyone’s situation, but I could see why it would be appealing. When you’re in a situation that every dollar counts (kind of like we are) it does make a big difference.

  7. Congrats on fully funding the IRA! Not an easy thing to do, especially given the additional info that you also have a 401(k), not to mention living in NYC on a modest salary. And of course, thanks for the shout out. I think as long as people are saving money, they shouldn’t stress the Traditional vs. Roth too much. But the Traditional route definitely has some benefits that get glossed over far too often.

    1. That post pretty much altered my opinion on the Roth vs. Traditional routes so I was happy to give it some love. And agreed, in the end it’s more about saving for retirement and continuing to fund those accounts vs stressing about HOW you’re doing it.

  8. I think you’re putting way too much emphasis on whether or not you owe any additional taxes at year-end (obviously you owe money, you just already had it withheld). In general, it’s not a good idea to take any action for the sole reason of getting a tax deduction (credit, maybe). I think you could have made an argument for using the traditional IRA based on tax diversification in your retirement savings, if not the math behind your current and expected brackets. It’s dangerous to conclude that the traditional IRA is preferable to the Roth simply because you get the tax deduction now, which is what you imply by caring so much about not owing additional tax and might confuse a PF/tax neophyte.

  9. Referring to Matt’s excellent Roth vs Traditional break down was one way I hoped to better explain the pros and cons to the neophytes. I understand what you’re saying, but this was really more a story about my personal experience this year and why I see some value in traditional because Roth is constantly being heralded as the way to go. Like I said, I’m down with Roth. Use it for my 401(k), but in some ways traditional can offer an advantage. You are right that hitting the point of tax diversification in retirement savings could have rounded out the piece better. Perhaps that’s an entirely separate post to come!

  10. My dad did this, can you not do this if you’re married? He doesn’t have an employee sponsored retirement account as he’s a contract employee so perhaps this is why. We have 403(b) plans at my work but no one has yet given me full instructions on how to sign up (I’ve been there over a year) so I still haven’t signed up yet…

    I will say I’m more in a believer of traditional IRA. Unless you think you’ll be spending money LIKE CRAZY in retirement, I don’t see how a ROTH makes sense. I don’t foresee tax rates ever going crazy high as people predict but who knows… I’m not an economist.

  11. It isn’t until now that I am truly embracing topics such as this. If I had been doing what I’m doing now a long time ago, things would have been very different for me right now. Thank you so much for this post.

  12. Well first Erin, congrats on fully funding a retirement account. At such a young age, I think it’s great that you’re simply saving for retirement, whether it be traditional or roth. They both have distinct advantages, but I think the big thing is that you’re saving for retirement. Any money, whether it be in a Roth or Traditional IRA is going to have loads of time to compound. Totally awesome.

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