OT: financial question

[krazy_kenny1]

I'm 22 and have been at my first full-time job for almost a year. My tax rate is about 20%. Due to taxable scholarship money from my last semester at college, I owe about $535 in taxes this year. Since I work for a small start-up, I've been building up a job-loss buffer in a fairly high-interest savings account (about 5%) for awhile. The plan was to start a Roth IRA once I had accumulated $5000 in the savings account, while continuing to attribute to the savings account once the yearly max contribution to the IRA had been reached. I now have $4000 in the account. I can eliminate the $535 in taxes if I start a traditional IRA now by emptying my savings account into it. The Roth IRA is really what I need, so should I just pay the taxes? I know I could convert the traditional to a Roth later, but then I'd just be paying the taxes then, so that seems dumb. After thinking about it, it seems to me I should leave my savings alone and just pay the taxes and continue with the original plan, but more knowledgeable opinions are always welcome

[ComicSupply]

I am wondering a few things.

 

1. Were you eligible for the Hope Credit, or the Lifetime Learning Credit?

2. You must of grossed a lot of taxable income to owe the $535. Was the job witholding any taxes?

3. What was your exemption status?

[qualitycomix]

I'm 22 and have been at my first full-time job for almost a year. My tax rate is about 20%. Due to taxable scholarship money from my last semester at college, I owe about $535 in taxes this year. Since I work for a small start-up, I've been building up a job-loss buffer in a fairly high-interest savings account (about 5%) for awhile. The plan was to start a Roth IRA once I had accumulated $5000 in the savings account, while continuing to attribute to the savings account once the yearly max contribution to the IRA had been reached. I now have $4000 in the account. I can eliminate the $535 in taxes if I start a traditional IRA now by emptying my savings account into it. The Roth IRA is really what I need, so should I just pay the taxes? I know I could convert the traditional to a Roth later, but then I'd just be paying the taxes then, so that seems dumb. After thinking about it, it seems to me I should leave my savings alone and just pay the taxes and continue with the original plan, but more knowledgeable opinions are always welcome

 

It depends on what tax bracket you'll be in down the road. If you'll be in a higher tax bracket (ie making more money) when you do the conversion down the road, then bite the bullet and contribute to the Roth IRA now and pay the $500 in taxes. If you think you'll be in the same tax bracket when you do the conversion then it really doesn't matter except for the point of when you want to pay the conversion costs on it. Either way, you have to pay your $500. In addition, I'm not 100% positive but you may have to pay taxes on any earnings when you do the conversion as well which could significantly impact your decision.

 

So my recommendation would be to pay the taxes now and set up the Roth.

[silverage12c]

Wow . . . when I was 22, my biggest financial dilemma was whether I should buy a whole case of cheap beer, or indulge in a 6-pack of import brew!

 

Kudos to you for being so aware of the need to save for your future, and also for having the rainy day fund that you've accumulated. Not enough people take care of the basics like this so well.

 

IMO, when you're young and your income is relatively low, the Roth is definitely the way to go. You need the tax-break that a Traditional IRA offers much less than people that have higher earnings. Better to take the tax savings later in life when you begin to take the disbursements in retirement.

[krazy_kenny1]

I am wondering a few things.

 

1. Were you eligible for the Hope Credit, or the Lifetime Learning Credit?

2. You must of grossed a lot of taxable income to owe the $535. Was the job witholding any taxes?

3. What was your exemption status?

 

1. No and no, I had a full ride so I didn't pay any tuition or fees.

 

2. I had two jobs during 2006. The first was my part-time job during college and the second is my current full-time job. I made $13768.18 from the part-time and $1732.92 was deducted (for Federal income tax, SS Tax, and Medicare). I made $14550.00 from the full-time and $2808.44 was deducted (for Federal income tax, SS Tax, and Medicare). I also received $2500 of taxable scholarship money (received as a stipend that I didn't spend on deductible things like books...etc)

 

3. Single

 

My dad did my taxes this year like he's always done (I think he just uses TurboTax), so I have no experience with them whatsoever. Still, $535 sounds odd to me...

[Stronguy]

I'm not 100% positive but you may have to pay taxes on any earnings when you do the conversion as well

 

Yes, you pay taxes on anything you convert out.

[krazy_kenny1]

I'm not 100% positive but you may have to pay taxes on any earnings when you do the conversion as well

 

Yes, you pay taxes on anything you convert out.

Not only that, but if you have to withdraw funds from the traditional IRA to pay those taxes, then you also pay a 10% penalty on what you withdrew

[qualitycomix]

I'm not 100% positive but you may have to pay taxes on any earnings when you do the conversion as well

 

Yes, you pay taxes on anything you convert out.

Not only that, but if you have to withdraw funds from the traditional IRA to pay those taxes, then you also pay a 10% penalty on what you withdrew

 

That's a double edged sword though. Since you can pull out contributions to a Roth with NO penalty, sometimes I'm tempted to do so for vacations, house repairs etc and tell myself that I'll put it back in later on. With a Traditional, there's no such consideration.

[Paratrooper]

With your financial portfolio using Turbo Tax is a waste. Doing your taxes by hand, when you don't have any real estate assets, or are married, is very simple. You can deduct things by doing it by hand that you might miss by using Turbo tax.

[G.A.tor]

hello all...

coming from a financial background (I have a BSBA/Finance and a BSBA/Economics), I have to agree with your self perscribed diagnosis...pay the taxes and set up the Roth now...don't get sidetracked with maxing the roth out right now, if you need to use some funds to pay the taxes...see about contributing to a traditional IRA via your full time employment (that will reduce your future Federal tax liability) and continue to save up and fund your Roth (and remember, you can fund your roth through out the year, you don't have to pop all at once)...

good luck

rick

[jeranimal]

Kenny

I applaud your ability to save at such a young age!

 

Most financial advisors recommend that you have 3 months of take home pay in a rainy day fund. So if you're trying to build up a job-loss (rainy-day) fund, I wouldn't put all of the money into a Roth or Traditional IRA yet. I would put part 1/2 of it into a money-market fund (or leave it in your current savings acct) and the rest it into a Roth IRA. The money-market is more liquid and can be used in emergencies.

 

If you need to, you can take the money for taxes out of your savings and replenish it later.

 

Just my two cents!

[krazy_kenny1]

Everything I've heard seems to support my initial opinion that I should just pay the taxes and continue with my original plan. Thanks everybody

[tth2]

You don't have a 401(k) at work? If you have one, particularly if your employer makes a matching contribution, you would be best off maxing out on that, at least up to the level your employer matches, before you think about anything else (although I like your putting together a "buffer" savings fund together, because everyone should have cash savings of at least 2 months' (and preferably 3) take home salary).

[krazy_kenny1]

You don't have a 401(k) at work? If you have one, particularly if your employer makes a matching contribution, you would be best off maxing out on that, at least up to the level your employer matches, before you think about anything else (although I like your putting together a "buffer" savings fund together, because everyone should have cash savings of at least 2 months' (and preferably 3) take home salary).

We don't yet...being a small start up and all.

[SpideyZombie-migration]

Im only 21 but i am graduating with my degree in finance this semester.. I highly recommend paying the taxes and going with the Roth IRA.. The non taxed end sum will be much higher than the taxes you are going to be paying now. I would try to find some scholarships that were tax free next time though ... But yeah all of my professors have told me to get a Roth IRA and i personally believe it is the best option.. Better than most 401k's.

[Nostalgic Attic]

Seems like everyone is recommending to pay the taxes and contribute to a Roth. I think you have to ask yourself if the rainy day fund is something you want to do or need to do. True a 3 month fund is a rule of thumb, but its necessity depends on your marital status, how many people count on you for financial support, job prospects and fall back situation with your family. The $500 you're paying to the IRS could be worth $15,000 at retirement.

 

....just my two cents

[SpideyZombie-migration]

ok i thought a little more about this and i have solved your problems. Donate money to me and then use it as a tax write of...

EVERYONE WINS

[phoenix215]

ok i thought a little more about this and i have solved your problems. Donate money to me and then use it as a tax write of...

EVERYONE WINS

 

 

Or you could become an international criminal overlord...let's see the IRS try to get taxes out of you then!!

[shadroch]

It doesn't need to be an either or situation. You can put some of your savings into the IRA and leave some for your rainy day fund,something I believe is quaint and out of touch with reality. Putting $1500 into the IRA will bring your tax burden down quite a bit,while leaving you a nice reserve.

[tth2]

leave some for your rainy day fund,something I believe is quaint and out of touch with reality. Putting $1500 into the IRA will bring your tax burden down quite a bit,while leaving you a nice reserve.

Why in the world is having a rainy day fund (i.e., cash) out of touch with reality? Stuff happens. You or a family member have to go to the hospital and not everything's covered by insurance. Car breaks down. You get laid off. If you have to tap into your IRA, you have to incur penalties. Plus, if you've put your IRA into stocks (which is what a young person should do), there's no guarantee that in the short term you'd be able to sell the stocks at above your purchase price. Hopefully you never need it, but I'm a firm believer in having 2-3 months of take home salary in cash, in a bank savings account, before you start investing your savings. Why live life on the edge?

 

The only exception is a 401(k) where the employer matches, because then you're effectively getting free money so the benefit of contributing to the 401(k) is too great. Put the cash away until you hit the 2-3 month mark, and then start investing afterwards. If you're disciplined in putting money away, and your salary continues to rise as you get older, in no time you'll have plenty of money socked away.