Did I miss a Roth Conversion opportunity?

[Dalmuti]

I am 30 and DW is 28. Our combined income is 125k, and we have about 150k saved for retirement and no debt other than a 110k mortgage. Because both our employers generously contribute tax deferred retirement money, and because we expect tax rates to be higher when we retire, our own contributions have been focused on Roth accounts. We contribute the max to each of our Vanguard Roth IRAs, and anything we contribute beyond that goes to my Roth 403(b) at work (no match).

I just realized though that I may have missed an opportunity for better tax treatment of my savings. Our plan has always been to begin having children at this age (DW is now pregnant with our first). So DW will be starting her 7ish year gap from working in early 2014. This will mean that our income will decrease to about 65k, putting us in the 15% bracket instead of the 25% and probably significantly decreasing the amount that we will be able to save for retirement.

It looks like we could have been better off if we had made some of our contributions to a traditional IRA and had gotten the 25% deduction (we already itemize). Then we could bank the tax savings and use it to do a Roth conversion once we are in the 15% bracket. Is this true or is there something I'm missing? I guess if we had a large amount of earnings then 15% of the new value might be close to 25% of the original contribution, but that seems unlikely at least for the most recent contribution. Anything I can do now to take advantage of our tax bracket lowering next year?

 

[Dalmuti]

Might be self-explanatory, but I forgot to mention that the 7ish year gap is because DW will be staying home until the kids start school. I know this isn't the best plan for our retirement, but having one of the parents stay home is important to us.

 

[mjgruber]

Roth

Yes, you need to look at your Tax bracket each year independently and determine what you think will be a lower tax bracket ( today or way in the future ). Same goes for the Roth conversion.

 

[kaneohe]

Sounds to me that you've got it down pat (now). The usual advice is to always be comparing what tax benefit you get now vs the price you pay later on when you withdraw. In the future low bracket, the Roth might be better and if you have extra headroom in the 15% bracket, folks usually consider Roth conversions or LTCG sales .........for the latter, pay 0 taxes and reset the basis higher if you wish to repurchase and maintain the position. Just be sure you understand how that works by using tax software or a tax calculator like Taxcaster (google it) to check your assumptions.

 

[Sesq]

You might be well positioned to convert your wife's existing 401(k) over those 7 years at 15% after rolling it into an IRA.

 

[Animorph]

Same thing holds for the early portion of ER, where you may have very low or no formal income. You may also be able to use a tIRA to fill in the lower tax brackets in retirement, even if you aren't Roth converting.

Also keep in mind that even in the 25% tax bracket, some of your income is taxed at 10% and 15%, lowering your average tax rate. You are paying 25% exactly on your last few dollars of Roth contributions now. Even if you hit the 25% tax bracket taking withdrawals from a traditional IRA, your average tax rate should be something below 20%.

Mathematically, losing 15% of your withdrawals to taxes gives you the identical results as losing 15% of your contributions to taxes, regardless of growth or even losses in your retirement account. So just minimize tax rates against Roth contributions and tIRA withdrawals and don't worry about the number of dollars paid.