No aversion to conversion: IRA to Roth
Gay and lesbian couples who choose to have children often do so later in life. After all, no children are conceived “accidentally” in LGBT families. A parent who chooses to stay home to raise the children can take advantage of a great tax break. It’s difficult to adjust to not having an income, but one upside is that it puts you at a very low — even zero — tax bracket. If you have a 401(k) from previous employment or a traditional IRA, take advantage of the opportunity to transfer the money into a Roth IRA. You’ll have to pay income tax on the amount transferred, so be sure to have money on hand to cover the taxes. Once money is in a Roth, you never have to pay tax on it again. You don’t have to transfer the entire amount at one time, so if you plan to stay home for the first three years of Junior’s life, you can break up the transfer over the three years — that should help keep you away from the higher tax brackets.
Example: Susan and Carol are expecting a new baby and plan to have Susan stay home for five years until the child enters kindergarten. Carol has a good paying job and can cover the bills, if they tighten their belts a bit. Susan previously worked for seven years in telecommunications and has $50,000 in a 401(k) with her former employer. Susan can transfer the 401(k) funds into a traditional IRA, or as of 2008, you can distribute funds directly from a 401(k) into a Roth. For each of the next five years Susan can transfer $10,000 into a Roth. On her 1040, she enters $10,000 IRA distribution on lines 15a and 15b. Assuming Carol, not Susan, claims the child as dependent (after all, Carol will be in the higher tax bracket), Susan subtracts $5,450 for a standard deduction and $3,500 for her exemption, leaving a taxable income of $1,050. She’ll owe tax of $106, for an average tax rate of 1%. Not bad.
You might think we’re getting a great tax break just because Uncle Sam doesn’t recognize LGBT marriage, but remember that we’re missing out on spousal IRA contributions. Straight couples are allowed to contribute $5,000 to the stay-at-home parent’s IRA (Roth or traditional). Susan is missing out on $25,000 in additions to her IRA, which could grow to over $171,000, by the time she retires (assuming 25 years at 8%). LGBT parents — unmarried persons in the eyes of the law — can only contribute to an IRA if they have earned income.
Numbers in this examples are for tax year 2008.
Image credit: Futurowoman at Flickr.
By day, Helen engineers new materials to make computer chips cheaper, better, and faster. When the son goes down (pun intended), she writes about personal finance at Affine Financial Services.
Helen, I have my Roth IRA since I am self-employed. I was able to max out my contributions last year at $5000. This year I probably won’t get close to that. But it’s nice to at least have something put away for “retirement.”
One thing about Roth IRA’s – even though they are not taxed at the beginning, money will be taxed if you take the money out before you are 59. The one exception is for first time home buyers – you can withdraw the money at a lower penalty if you are using it to buy a home.
Hey, Serena. Glad to hear that you’re conscientiously working on your retirement fund, but I’m confused by your second paragraph.
Maybe you meant “traditional IRA” instead of Roth, as in…
One thing about traditional IRA’s – even though they are not taxed at the beginning, money will be taxed if you take the money out before you are 59. The one exception is for first time home buyers – you can withdraw the money at a lower penalty if you are using it to buy a home.
If that’s what you meant, then you are spot on. If you qualify for the tax deduction when you put your money into a traditional IRA, you don’t pay the tax up front (hence the deduction), you pay it when you take it out in retirement. If you take it out before you turn 59 1/2 you owe income tax PLUS a 10% penalty (for messing with Uncle Sam).
There are eight ways to take it out without paying a penalty — first time home purchase, as you point out, is one of them.
http://beginnersinvest.about.com/cs/iras/a/aairafees.htm
Yes, that’s what I meant. Sorry for the confusion! It all gets a little complicated when there’s so many types to keep separated in my brain.