Roth Vs Traditional IRA with Uncertain Income

[BG2008]

I want to take advantage of the IRA contribution early during the year so that the money can compound early on.  Since investing is a full time job for me, it's unclear what my income will be for 2014.  How do I choose between traditional vs Roth under these circumstances? 

 

1) If contribute to Roth and income exceeds $181,000 for married filing jointly, then the contribution and earnings will have to be withdrawal or re-characterized as traditional.  How does  a re-characterization work?  What is the penalty if the income is withdraw? 

 

2) If contribute into a traditional and wish to convert into Roth at year end?  What are the penalties and process? 

 

3) Someone had mentioned that it's a good strategy to open up a separate account for the new contribution to isolate earnings associated with the new contribution. 

 

Thanks guys 

[Ross812]

If you make more that 191k you can't deduct your contributions to your Traditional IRA. The phaseout starts at 181k (assuming your wife doesn't still work in which case it is 116k)

 

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/2014-IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-if-You-are-NOT-Covered-by-a-Retirement-Plan-at-Work

 

You are allowed to withdraw your contributions to a Roth IRA the year they are made penalty free. So if you did exceed 181,000 you would have to withdraw the 11k you put in the Roth. You would have to pay taxes on the ST capital gains. I may be wrong, but ST capital gains on your 11k contribution is the penalty you have to pay if you have a good year.

[BG2008]

Yeah,

 

I'm trying to figure out what the penalty is exactly if the AGI exceeds 181k.  I wonder if I'm better off just putting money into the traditional IRA giving the uncertainty.     

[Ross812]

Have you set up a solo 401k? You could then put in 17.5k regardless of income.

 

Edit: Looking into this further (I could be in a similar situation) You should make your contributions to the Traditional IRA then prior to the end of the year convert the Trad. IRA to a Roth. There are 2 scenarios:

 

1. You make less that 116k - You can keep the money in the Trad. IRA and take the deduction.

 

2. You make more than 181k - You cannot take the Trad. IRA deduction. Covert the Traditional to a Roth and pay taxes on any gains made on the 11k you contributed that year.

 

http://www.retirementincomevisions.com/retirement-income-visions/2010/03/two-steps-to-a-nontaxable-ira-for-high-income-individuals.html

[AtlCDore]

You may want to speak with your accountant to make sure it is considered ordinary income vs investment income.  If you generate investment income, I think you are somewhat limited in regards to placing it into an IRA.  If you can do so, take a look at a SEP IRA.  From what I remember from several years back, I was able to put much more into a SEP IRA.

[watsa_is_a_randian_hero]

are you self employed?  do the SEP or individual 401.  You don't have the same income limits then. 

 

If not, I wouldn't bother contributing until you know what your income is.  It wouldnt be worth the hassle of trying to reverse. 

 

If your income is very low or negative in a year, thats when you should convert your IRA's to roth!

[Kiltacular]

are you self employed?  do the SEP or individual 401.  You don't have the same income limits then. 

 

If not, I wouldn't bother contributing until you know what your income is.  It wouldnt be worth the hassle of trying to reverse. 

 

If your income is very low or negative in a year, thats when you should convert your IRA's to roth!

 

Yes, if you are self-employed this is the route to go.  Based on your comments, I would choose the self-employed 401k over the SEP IRA because you can contribute the salary deferral ($17,500 for 2014) as soon as you earn that much in a year.  The remainder of the contribution is dependent on your earnings from 2014 and is up to an additional $34,500.

 

I highly recommend Fidelity.  They have outstanding customer service for this.  Call and ask to speak to a retirement specialist.  You can find a lot of detail on their website to see the differences.

 

https://www.fidelity.com/retirement-ira/small-business/self-employed-401k/overview