Is ACA credit worth tIRA vs Roth IRA?

[Hermit]

I'm trying to figure out how to advise DD (age 25) on ACA when she leaves my health plan. Her income is about $29,000. The ACA calculators show tax credit of about $5/year for that level of income. If she contributes $5,500 to a traditional IRA, her tax credit is about $1500/year. By contributing to a traditional IRA instead of a Roth she can capture that $1500 dollars in tax credits essentially reducing her IRA contribution.

Would it make sense to capture this extra money now knowing she will likely pay at a higher tax rate and also pay taxes on gains at retirement or would it make more sense to continue Roth contributions?

 

[meierlde]

I'm trying to figure out how to advise DD (age 25) on ACA when she leaves my health plan. Her income is about $29,000. The ACA calculators show tax credit of about $5/year for that level of income. If she contributes $5,500 to a traditional IRA, her tax credit is about $1500/year. By contributing to a traditional IRA instead of a Roth she can capture that $1500 dollars in tax credits essentially reducing her IRA contribution.

Would it make sense to capture this extra money now knowing she will likely pay at a higher tax rate and also pay taxes on gains at retirement or would it make more sense to continue Roth contributions?

Given that by makeing the IRA contribution she effectivly gets a double tax relief on the contribution, 825 or so directly on the income tax and about 1500 from the ACA, meaning that about 1/2 of the contribution is effectivly paid for by the government, it sounds like the t-ira is better. Even assuming that she ends up in retirement in the 43% effective bracket she is ahead in terms of he own money. Plus of course guessing what will happen in 30+ years means you have to have a reliable crystal ball.

 

[Hermit]

Given that by makeing the IRA contribution she effectivly gets a double tax relief on the contribution, 825 or so directly on the income tax and about 1500 from the ACA, meaning that about 1/2 of the contribution is effectivly paid for by the government, it sounds like the t-ira is better. Even assuming that she ends up in retirement in the 43% effective bracket she is ahead in terms of he own money. Plus of course guessing what will happen in 30+ years means you have to have a reliable crystal ball.

Thanks meierlde,

That was my gut feeling. I just wanted to ask the question to see if anyone here had some insight in this area that I was not seeing or some suggestions on how to quantify the difference. I guess it would make sense to make a spread sheet showing both approaches.

She gets 10% credit on IRA contributions ($550), but that still gets close to 50% total although the 10% is also available on Roth IRA contributions.

 

[Animorph]

For my specific case, the tradeoff between a tuition credit of $2.5k and a Roth conversion of $40k was about break even. I think it's pretty much a sure thing that getting the ACA tax credits will be the better choice over making Roth contributions.

 

[GrayHare]

What about contributing to a tIRA then using the ACA credit to pay the tax on converting the contrib to Roth? I'd guesstimate the tax on the conversion is less than the credit she'll receive.

 

[Chuckanut]

My situation was also close to a break even given my assumptions about the future - time will tell. So I decided to do a Roth conversion so as to give myself more tax flexibility in future withdrawals. Keeping some options open seems wise. Diversification - Don't Retire without It.

 

[Hermit]

What about contributing to a tIRA then using the ACA credit to pay the tax on converting the contrib to Roth? I'd guesstimate the tax on the conversion is less than the credit she'll receive.

Doesn't converting to a Roth increase the income for the year? Her ACA credit increases with every decrease in AGI.

This brings up a good point. When her income is higher than the credits allow, I think that would be the time to convert to Roths.

 

[GrayHare]

Doesn't converting to a Roth increase the income for the year? Her ACA credit increases with every decrease in AGI.

Aha, good point, I forgot about that. Sounds like tIRA now and Roth sometime in the future is the way to go.

 

[Fermion]

Definitely tIRA. $1500 plus perhaps $500 saving in taxes = $2000 immediate return on $5500 investment = 36% guaranteed return.

I would love to have a guaranteed 36% return.

If she really wants a Roth though, she could alternate years and do a conversion and a direct Roth contribution in the alternate years. Even if this bumped her MAGI up to $40,000 she still would only pay about $1000 in tax on the conversion, thus coming out $1000 total ahead.

 

[prototype]

For my specific case, the tradeoff between a tuition credit of $2.5k and a Roth conversion of $40k was about break even. I think it's pretty much a sure thing that getting the ACA tax credits will be the better choice over making Roth contributions.

Given that by makeing the IRA contribution she effectivly gets a double tax relief on the contribution, 825 or so directly on the income tax and about 1500 from the ACA, meaning that about 1/2 of the contribution is effectivly paid for by the government, it sounds like the t-ira is better. Even assuming that she ends up in retirement in the 43% effective bracket she is ahead in terms of he own money. Plus of course guessing what will happen in 30+ years means you have to have a reliable crystal ball.

+1 and +1 IMO , I hope (in a positive, well wishing manner) that since it appears DD is just starting out in her career, her income will be going up faster than mid/late career people (e.g. promotions). So the window to "exploit" the ACA credit is/will be relatively short. Grab it (tIRA) while you can!

 

[MichaelB]

I'm trying to figure out how to advise DD (age 25) on ACA when she leaves my health plan. Her income is about $29,000.

That sounds like a lot of tax credit for a 26 year old. Her premium shouldn't be that high. Seems to me she should be eligible for a low cost policy and still be able to make ROTH contributions due to her low overall tax rate.

 

[Hermit]

That sounds like a lot of tax credit for a 26 year old. Her premium shouldn't be that high. Seems to me she should be eligible for a low cost policy and still be able to make ROTH contributions due to her low overall tax rate.

You are correct. 1500 is the amount she will pay for a silver plan. The tax credit is 839. Still, I think that is worth doing. In addition, she will get a 10% credit for savings and not pay taxes on the 5500 (15%).

ACA tax credit 839
savings credit 550
Tax savings 825
Total 2214

I used Kiser Family Foundation calculator:

29,000 income - 5500 IRA = 23,500 AGI

She has not shopped for plans yet, but is setting up her IRA contributions for this year. She will put 2000 in her IRA this year. 200 of that is from the savings credit for 2013 contributions. I want to show her that she can effectively contribute 3286 while increasing her IRA by 5500. (Dad will probably need to front some of the extra 3286 and maybe help a little in future years, but still I think it is a good deal.)

 

[MichaelB]

You are correct. 1500 is the amount she will pay for a silver plan. The tax credit is 839. Still, I think that is worth doing. In addition, she will get a 10% credit for savings and not pay taxes on the 5500 (15%).

ACA tax credit 839
savings credit 550
Tax savings 825
Total 2214

I used Kiser Family Foundation calculator:

29,000 income - 5500 IRA = 23,500 AGI

She has not shopped for plans yet, but is setting up her IRA contributions for this year. She will put 2000 in her IRA this year. 200 of that is from the savings credit for 2013 contributions. I want to show her that she can effectively contribute 3286 while increasing her IRA by 5500. (Dad will probably need to front some of the extra 3286 and maybe help a little in future years, but still I think it is a good deal.)

Right. I [-]may have[/-] misread your OP as $5K.

Nothing wrong with that last part. This dad also encouraged the early IRA contributions by helping a bit. Even a little bit now will pay handsomely when it's their time to retire.

 

[pb4uski]

It sounds to me like the tIRA is the way to go - she'll get the tax benefit + the Obamacare insurance benefit + the saver's benefit. If she ER's and starts to do Roth conversions her rate should be low - our federal marginal rate on Roth conversions to the top of the 15% bracket was 7.2% in 2014 so it seems to me the tIRA is the way to go.

 

[Hermit]

It sounds to me like the tIRA is the way to go - she'll get the tax benefit + the Obamacare insurance benefit + the saver's benefit. If she ER's and starts to do Roth conversions her rate should be low - our federal marginal rate on Roth conversions to the top of the 15% bracket was 7.2% in 2014 so it seems to me the tIRA is the way to go.

I was thinking she could wait until the market tanks and do a conversion at that time. With the time span she is looking at, chances of a market melt down at some point are certainly in her favor. Converting in the early years of RE will be a good backup plan.

 

[Hermit]

I found another error in my calculations:

The savings credit is only applied to up to $2000 so the max savings credit at 10% is $200 not $550.

ACA tax credit 839
savings credit 200
Tax savings 825
Total 1864

This tax strategy stuff is not easy. I'm starting to understand why Caterpillar paid PricewaterhouseCoopers the big bucks to do their off-shore strategy!

 

[ziggy29]

It is very situation-dependent. In my case, the case for a TIRA over a Roth is a slam-dunk, even in the 15% bracket these days. Not only does the subsidy create what is effectively another 15%, give or take (in that about 15 cents of subsidy is gained per dollar of deferred income), but also because I need to keep our MAGI below 300% of the poverty line because of my American Indian status. That turns a $6000 deductible and $12000 OOP maximum into $0 and $0 on the Exchange (i.e. *no* cost sharing).... as long as I stay below that magic number (which is about $46K). And since I've started working more again, our income would be in the mid-$50s before tax deferrals. So obviously the incentive to keep MAGI below $46K is massive, and a Roth can't help us there.