Better Off Divorced?

[ProGolferWannabe]

I am doing my 2011 taxes now. I hate this annual exercise. My wife and I make approximaely the same income---$120K each per year. We are both salaried. Our house is paid off; we max out our 401k contributions, and max out our HSA. Our combined MAGI is too high for us to contribute to Roth IRAs. I also understand that because our incomes are nearly identical that we likely pay more Federal income tax than we would if we were not married and filed individually.

I looked at the IRS regs--it appears that if were single (and filed as such), we would both be elligble to contribute to Roth IRAs as each of our MAGI would be less than the $122K max, and our total combined tax liability would be lower.

Am I missing something obvious, or financially speaking are we be better off divorced and "shacking up" than staying married? Wife saw me typing this---her answer is "no" regardless of the finanical ramifications. I am glad I married a romantic, but I still would like to know the answer.

 

[yakers]

Oh, Oh, oh, what a great idea, let me run it past the wife


Some times you just gotta forget the numbers.

 

[bbbamI]

 

[Nords]

Am I missing something obvious, or financially speaking are we be better off divorced and "shacking up" than staying married?

Well, the first obvious thing you're missing (that your spouse is telling you) is that the "divorce penalty" is much more punitive (and more hazardous to your longevity) than the marriage tax...

The second obvious thing you're missing is that you can still contribute to a conventional (non-deductible) IRA. (My spouse and I had to do this all the time during our dual-working-couple years.) What you can now also do these days is contribute to two non-deductible IRAs and immediately convert them to Roths. It's called a "backdoor Roth IRA":
The Serial Backdoor Roth, A Tax-Free Retirement Kitty - Forbes

Income restrictions on conversions were lifted starting Jan. 1, 2010, so anyone—regardless of income—can convert a traditional IRA to a Roth.

 

[Golden Mean]

There was a Love Boat episode that covered this very subject. I suggest you find it, rent it and take notes.

GM

 

[ProGolferWannabe]

Well, the first obvious thing you're missing (that your spouse is telling you) is that the "divorce penalty" is much more punitive (and more hazardous to your longevity) than the marriage tax...

The second obvious thing you're missing is that you can still contribute to a conventional (non-deductible) IRA. (My spouse and I had to do this all the time during our dual-working-couple years.) What you can now also do these days is contribute to two non-deductible IRAs and immediately convert them to Roths. It's called a "backdoor Roth IRA":
The Serial Backdoor Roth, A Tax-Free Retirement Kitty - Forbes

Very true on the first point. Very funny too.

Second point--yes, I did understand this was an option, but I have previously made pre-tax IRA contributions. I understand that if I do this so-called "backdoor", I will need to pay tax on the pro-rated portion of the pre-tax contributions that are converted to the Roth; I am not allowed to convert just the post tax contributions. I was trying to avoid this.

Thanks for the laugh though.

 

[ProGolferWannabe]

There was a Love Boat episode that covered this very subject. I suggest you find it, rent it and take notes.

GM

No reason for me to watch Comedy Central anymore--I can get my laughs along with sound financial advice all here in one place.

 

[Helen]

Without the marriage certificate, one of you may be subjected to the estate and/or inheritance tax should one of you pass before the other.

 

[Nords]

Second point--yes, I did understand this was an option, but I have previously made pre-tax IRA contributions. I understand that if I do this so-called "backdoor", I will need to pay tax on the pro-rated portion of the pre-tax contributions that are converted to the Roth; I am not allowed to convert just the post tax contributions. I was trying to avoid this.

Well, now you're in the classic "should I convert my conventional IRA to a Roth" flowchart. You're probably in a punitively high tax bracket already, but you may want to revisit this decision when you ER and before you have to start taking RMDs. During that period you might be in a lower tax bracket (for converting a little each year) than the tax bracket you'd be in when RMDs start.

We know that when spouse's pension starts that we'll be in the 25% income tax tax bracket. We've been converting a little IRA every year for almost a decade, up to the top of the 15% income tax bracket. If you think you're going to do that too, then it'd still be worth making those conventional IRA contributions instead of making no IRA contributions at all.

 

[ProGolferWannabe]

Well, now you're in the classic "should I convert my conventional IRA to a Roth" flowchart. You're probably in a punitively high tax bracket already, but you may want to revisit this decision when you ER and before you have to start taking RMDs. During that period you might be in a lower tax bracket (for converting a little each year) than the tax bracket you'd be in when RMDs start.

We know that when spouse's pension starts that we'll be in the 25% income tax tax bracket. We've been converting a little IRA every year for almost a decade, up to the top of the 15% income tax bracket. If you think you're going to do that too, then it'd still be worth making those conventional IRA contributions instead of making no IRA contributions at all.

This makes sense--thank you for the suggestion. I have been bascially been saving/investing the equivalent amount I would invest in a Roth IRA in an after tax account (blended Vanguard fund), so I could easily shift my investments from "after-tax" to "after-tax IRA".

 

[pb4uski]

I am doing my 2011 taxes now. I hate this annual exercise. My wife and I make approximaely the same income---$120K each per year. We are both salaried. Our house is paid off; we max out our 401k contributions, and max out our HSA. Our combined MAGI is too high for us to contribute to Roth IRAs. I also understand that because our incomes are nearly identical that we likely pay more Federal income tax than we would if we were not married and filed individually.

I looked at the IRS regs--it appears that if were single (and filed as such), we would both be elligble to contribute to Roth IRAs as each of our MAGI would be less than the $122K max, and our total combined tax liability would be lower.

Am I missing something obvious, or financially speaking are we be better off divorced and "shacking up" than staying married? Wife saw me typing this---her answer is "no" regardless of the finanical ramifications. I am glad I married a romantic, but I still would like to know the answer.

You don't need to divorce. If Roth is your focus the married-filing-separately limits for Roths are the same as a single, but I suspect that your overall tax bill might be higher. Might be worth looking into though.

 

[ProGolferWannabe]

You don't need to divorce. If Roth is your focus the married-filing-separately limits for Roths are the same as a single, but I suspect that your overall tax bill might be higher. Might be worth looking into though.

Could you point me to that reference? What I saw was they were the same only if we did not live together for any part of the tax year.

 

[pb4uski]

Got this off the internet, I assume that it is right but have not checked it back to tax forms, instructions or anything like that. But note that the Single and MFS limits are the same.


Historical Roth IRA Income Limits

Every year, the income limits are evaluated against inflation and incomes to determine if a change is needed. In the past five years there has only been one instance where the limit did not change for the two major categories.

Year	Married Filing Jointly or Qualifying Widower	Married Filing Separately (lived with spouse)	Single, Head of Household, or Married Filing Separately
2012	$173,000 - $183,000	$0 - $10,000	$110,000 - $125,000
2011	$169,000 - $179,000	$0 - $10,000	$107,000 - $122,000
2010	$167,000 - $177,000	$0 - $10,000	$105,000 - $120,000
2009	$166,000 - $176,000	$0 - $10,000	$105,000 - $120,000
2008	$159,000 - $169,000	$0 - $10,000	$101,000 - $116,000
2007	$156,000 - $166,000	$0 - $10,000	$99,000 - $114,000
2006	$150,000 - $160,000	$0 - $10,000	$95,000 - $110,000

 

[ProGolferWannabe]

Got this off the internet, I assume that it is right but have not checked it back to tax forms, instructions or anything like that. But note that the Single and MFS limits are the same.


Historical Roth IRA Income Limits

Every year, the income limits are evaluated against inflation and incomes to determine if a change is needed. In the past five years there has only been one instance where the limit did not change for the two major categories.

Year Married Filing Jointly or Qualifying Widower Married Filing Separately (lived with spouse) Single, Head of Household, or Married Filing Separately
2012 $173,000 - $183,000 $0 - $10,000 $110,000 - $125,000
2011 $169,000 - $179,000 $0 - $10,000 $107,000 - $122,000
2010 $167,000 - $177,000 $0 - $10,000 $105,000 - $120,000
2009 $166,000 - $176,000 $0 - $10,000 $105,000 - $120,000
2008 $159,000 - $169,000 $0 - $10,000 $101,000 - $116,000
2007 $156,000 - $166,000 $0 - $10,000 $99,000 - $114,000
2006 $150,000 - $160,000 $0 - $10,000 $95,000 - $110,000

Thank you. From IRS Publication 590, I read the following: "If you have taxable compensation and your filing status is married filing separately and you lived with your spouse at any time during the year and your modified AGI is $10,000 or more, you cannot contibute to a Roth IRA"

 

[Animorph]

We were in about the same situation when I was working. There was a significant marriage penalty in the federal taxes. The Bush cuts helped a bit, so look out if they are allowed to expire! I'm retired now, so we're down to one salary and should be benefitting from that marriage bonus when the incomes are very different. Maybe you should do the same!

 

[ls99]

Am I missing something obvious, or financially speaking are we be better off divorced and "shacking up" than staying married? Wife saw me typing this---her answer is "no" regardless of the finanical ramifications. I am glad I married a romantic, but I still would like to know the answer.

About 25 years ago neighbors across the street in a NY suburb did divorce, specifically to lower taxes. Did it very quietly most in the neighborhood did not know, continued life as before, their kids found out after the father died.

Worked well for them for more than 20 years after divorce.

 

[Alan]

Don't know if this will apply in your case but I was never eligible to contribute to a Roth IRA or take deductions on a traditional IRA. What I did was contribute the max into my 401k and also made trad IRA after tax contributions.

When I ER'ed I converted the entire tIRA to a ROTH and only paid tax on the gains. The following year I rolled over the large 401k to an IRA.

If I hadn't waited on the 401k rollover I wouldn't have been able to do the Roth conversion on the much smaller tIRA.

 

[pb4uski]

Thank you. From IRS Publication 590, I read the following: "If you have taxable compensation and your filing status is married filing separately and you lived with your spouse at any time during the year and your modified AGI is $10,000 or more, you cannot contibute to a Roth IRA"

Yup, sounds like they closed the door on that idea unless you live apart. So if one of you moave back in with you folks and you see each other a lot but don't live together then it might work

Hardly worth the hassle. Conversion is easier.

 

[glippy]

I hear you used to be able to divorce on December 31st, then Remarry January 1st, so that you could file as an individual.

Presumably that's why the IRS created the regulation governing "Divorces for tax purposes with intention to remarry."