Should you ever fill a non-tax-advantaged IRA (answer: maybe): An obnoxious post from having upper-middle class income

Now that DH’s income is back and I’ve GOTTEN PAID(!) for the first time this school year, it’s time to start up our obnoxious money posts again.  (Maybe you’ve noticed the new tag?)

This time we turn to planning for college.  If I’d known where we were going to be today I’d have planned things differently back when DC1 was born and opened up 457 plans earlier instead of saving in 529s or prepaying the mortgage.  Sunk cost!

People with upper-middle class income who plan to send their children someplace that isn’t a state school have an incentive to do some creative things with money before their children hit their junior year of high school.  The reason for this is that they’re on the margin of financial aid for some pretty expensive places.  Forbes has a bunch of articles about our “predicament”.  Check out the colorful charts in this one.  In it, you’ll note that AGI of 125K to 275K are eligible for some financial aid at various 4 year colleges if they play their cards right.

What does playing your cards right mean?  Well, a lot of playing your cards right is moving income from places that the CSS and FAFSA consider to be available for paying for college to those that the CSS/FAFSA consider to be out of bounds.  A big portion of that is moving regular assets and investments into retirement accounts.  (Here’s an article on how much cash is excluded from FAFSA formulas.  Here’s info on how different asset types are affected.)  5.64% of your non-excludable assets are expected to be available for paying for college.  Retirement savings, even non-tax-advantaged retirement savings, are not included in any of the financial aid calculations.

And that’s where the non-tax-advantaged traditional IRA comes in.  If your (married) joint adjusted gross income is less than 186,000 (for 2017), then you can just fill up a Roth and hide money into a retirement account in a tax-advantaged way.  If you have a workplace retirement plan available, then you can only get the full tax advantage from a traditional IRA plan if you make (jointly) less than $99,000.  More rules for single parents, those without retirement accounts, etc., are available here.

So if you’re in that upper-middle-class income range, have extra money floating around in taxable string-free investments and have children likely heading to private colleges in the future, it might be a good idea to start moving those over into traditional IRAs at the rate of $11K/year for a couple.  Should you do this instead of filling up a 529 with that 11K (if you can’t afford to do both)?  I don’t know– it’s probably best to sit down and crunch the numbers yourself given your age, preferred retirement age, targeted colleges, income, expected student loan rates, and so on.

Of course, because of loopholes in the tax code, it’s possible to turn that non-tax-advantaged traditional IRA into a backdoor Roth.  Here are some pitfalls to look out for if you choose to go that route.  And don’t do it if your eldest is in college or even a junior or senior because it will show up on an aid form according to Forbes.

So where are we?  Accumulating assets while we’re both employed.  DC1 on track to go to college in ~6 years.  That leaves ~4 years to try to move money around.  The easiest way to hide money from colleges would be to move to Paradise and to buy a house there because then we’d be back in debt with all our extra cash going towards retirement and the mortgage, plus there’s no guarantee I’d be employed at all.  But it’s unlikely we’d be able to actually do that given my, you know, career and stuff.  So it probably wouldn’t hurt to start making these asset moves.  (And we should replace our cars and remodel the kitchen at some point and maybe time finally getting that donor advised fund to a year that will count for financial aid calculators.)

I already save in a 403(b) and a 457 at work plus have required retirement savings on top of that  I don’t really *want* to save another $5,500 for retirement in my name.  DH only has a 401(k) and it’s not set up properly, so he ends up getting some of the money contributed back after the company does their taxes.  Right now I think we’re probably only going to do one traditional IRA and it will be DH’s.  I believe we have about $30 in another traditional IRA (we converted all our traditional IRAs to Roths back when it was first allowed, but one of them dripped during the conversion).  So it shouldn’t cost much to do the conversion unless the stock market goes crazy between putting the $5,500 in and converting.

If we made more, it wouldn’t be worth even thinking about all this stuff.  But we’re in that range.  And I’m not crazy about our state flagship.  So, this is where we are.

Have you ever put money away for retirement without getting the tax advantage?  Are you thinking about hiding assets from college financial aid calculators?

29 Responses to “Should you ever fill a non-tax-advantaged IRA (answer: maybe): An obnoxious post from having upper-middle class income”

  1. gasstationwithoutpumps Says:

    My son is a senior in college now. We gave up on even filling out the FAFSA, because the most it would get us is the UC “middle-class scholarship”, about a $500 savings a year. We had saved enough (in a 529) for a private college, but the stock market has done pretty well over the past 20 years, and we will have money left over in the 529 even after my son does a 5th year of college to get an MS.

    I think we’ll probably keep the 529 account around for a few years in case 1) he decides he wants a PhD or second MS, or 2) he ends up getting married and having children—we could then change the beneficiary to his child.

    • becca Says:

      I wonder- what happens to 529s when they are part of an estate? If they’d pass to your son, could you escape the differential (read: unfavorable) treatment of a grandparent 529 if they did?

  2. Revanche @ A Gai Shan Life Says:

    I sadly have no work-sponsored plan so I only get my puny $5500 a year in the IRA. It’s really pitiful. I keep hoping that there’s SOME other investment options for me but so far, no luck.

  3. chacha1 Says:

    fwiw I don’t think these money posts are obnoxious. I think they address stuff that most PF blogs don’t – those seem to be focused on shit like stock picks and maximizing passive income, vs actual financial security/stability in the face of inconsistent and unreliable public policy.

    that said, I got nothin’ because we don’t have enough left over to fully fund ONE retirement account, much less multiples, and if we had any kids they would be workin’ their way through trade school. :-)

    • nicoleandmaggie Says:

      those are maybe a little obnoxious too ;)

      I think the less obnoxious posts are ones about standard frugality/budgeting/trade-offs posts. Which is how we’ve spent a lot of our lives. Upper-middle-class really is a different mindset. A very comfortable but slightly obnoxious mindset. I would like to stay in it a lot longer! Maybe long enough to not have to leave it behind if/when one of us leaves a job.

  4. jasonedwards57 Says:

    Like the previous comment, I don’t think this is obnoxious. I mean you have worked hard to achieve this upper middle-class reality. There is some privilege involved compared to others, but that doesn’t still go against your awesome accomplishment.

    • nicoleandmaggie Says:

      Lots of people work hard and don’t get lucky. And I don’t want to think we’ve failed when we invariably wind back up at comfortably middle class if one of us gets hit with job loss.

  5. Rosa Says:

    we’re not strategic at all with our savings. I actually just convinced my husband to move a substantial chunk of money from a money market account into our general stock index investment account. But that’s all we do: max 401k, max Roth, a set amount into the 529, a small overpayment on the mortgage, the rest piles up in a money market and I try to siphon it off into a couple boring old index funds.

    We probably should see a planner for general tax & FAFSA planning tips, we’re 5 years out from kiddo starting college. But it’s both daunting and kind of feels like cheating – both of our parents managed to pay for flagship state universities out of pocket, mine from savings and his from current cash flow (for two kids at once – they were only a year apart in school!). Starting out with no debt put us way ahead on savings and we’re able to pass that on. That kind of inherited wealth seems like exactly the advantage the college aid system was designed to offset. It doesn’t feel like we need financial aid. Though maybe kiddo will want to go to Stanford and we will need it, who knows. A couple of our friends have actually oversaved and had to figure out how to disburse the extra 529 money – one’s kid got into a prestigious British school and it was astonishingly cheap, another’s second child did full ride merit. I think one of my nieces is doing mostly merit, too, though I don’t think her parents oversaved.

    The reasons for being so unstrategic are purely emotional, if you couldn’t tell. Aside from my irrational distaste for gaming the system, looking at our retirement/college savings makes my husband panic and want to stick to even lower-risk investments. Prying his main savings from a no-interest checking account into the money market was a big deal about 10 years ago and capping that and moving the overage into a stock fund was another huge effort.

    • nicoleandmaggie Says:

      If my kids end up at, say, my alma mater, I’ll feel like every penny was worth it. But if they end up at Harvard, I want/need that money more than Harvard does.

      I get your husband– I’m definitely guilty of keeping way too much in cash. I do know we’ll be getting at least one new car and redoing the kitchen before DC1’s junior year (the look-back period is now 2 years, not just 1).

      • Rosa Says:

        I don’t think we have the kind of money Harvard would think means we don’t need aid but that’s probably a dumb emotional conviction too. I just don’t feel upper middle class, you know? Today I had to browbeat him into buying new shoes instead of gluing the soles back to his running shoes (he’s still going to glue the soles back on those shoes but they’re now his painting shoes & he threw away the *really* old ones).

        I’ve been meaning to go to a CFP for years and I think your post just tipped the balance on really doing it.

        We are actually both feeling very justified in our cash savings preferences just now. Him because we have been using it – we just got our “new” car! we’ve been remodeling the kitchen, we’re in the process of choosing a bid for new windows, and we just resided the house a couple years ago. Me because we did all those things and there’s still cash sitting there.

  6. nicoleandmaggie Says:

    For those wondering what to do about the EO to destroy ACA markets, here’s the 5calls script: I called about that on Monday.

    Today I’m calling about the Tax bill:

    Here’s some more from indivisible if you’re able to get your rep to do a townhall:

    • Debbie M Says:

      Thanks. I called my Senators’ offices about the ACA sabotage; the interns had no information on the Senators’ plans.

      And I called my Rep. about Puerto Rican hurricane aid. The intern said my rep had opposed this because it was tied to bailing out the flood insurance program which is in debt. And instead we should be passing the separate measure to fix the flood insurance program.

      And I called about the Iran deal. Again, the intern did not know anything about my Reps views on this. Because it’s not important at all that Trump wants to reneg on yet another deal. Grr.

      All the interns were very nice and cheerful. I still feel really horrible after those calls. But that’s because my life is so wonderful that this is actually the worst thing I will do all week. Although on the sabotage one, I did enjoy telling the intern that this is not a competition between good guys and bad guys; it’s a country where we want everyone to win.

      Thank you so much for all your calls and encouragement. I will try to keep doing better.

      • nicoleandmaggie Says:

        My rep actually supported PR hurricane aid! He sometimes surprises me, since usually he’s just a rank-and-file tea partier.

        I hate calling too, but it’s really important. Thank you for making those calls! And remember, when you get through to Cornyn, you’re getting through to the entire Republican party, since he’s pretty much their bellweather.

        Last week I was feeling hopeless, but this week I was reminded that our work and resistance does matter. The senate has a *bipartisan* bill ready to go to combat the EO ACA sabotage. It was nice feeling that maybe my call helped that happen, and maybe your call will help it actually get passed!

      • Debbie M Says:

        “Bipartisan”? Blasphemy! Just kidding. I even read that Trump approves of that bill (what?) except that it doesn’t go far enough (what?). Anyway, sounds like possible good news, which is very dang nice for a change.

        Interesting comment about Cornyn. I will keep that in mind! And congrats on your rep having limits!

  7. SP Says:

    Looks like home equity is also excluded – why the preference of 457 over prepaying the mortgage? Just less cash accumulation? Does the fact that you don’t have mortgage payments hurt your FAFSA?

    I only recently realized the you can access a 457b any time without any penalty (assuming you no longer work there), which seems like a nice fit to keeping early retirement options open. Then again, many profs work well into old age, in which case the money is tied up until age 70 while you are still employed. So, I’m still undecided if we should do 403b or 457b for T. We did both for one year, but we can’t afford that long term along with my mortgage prepayments. I’m also getting concerned I’m locking up all of our money in accounts we can’t access w/out penalty until we are 60. But it seems a shame not to take the tax breaks now.

    I like the idea of paradise and hiding money in real estate! Silly careers getting in the way!

    • nicoleandmaggie Says:

      I don’t think all of home equity is excluded from the CSS.

      I’m pretty sure you can withdraw money from the 457 at age 59.5 even if you don’t leave the company (and you have to at age 70.5).

      457s seem to be more flexible than housing equity in the event of a jobloss. You could withdraw that money and use it to pay your regular mortgage bill while you wait for the house to sell. Of course, we prepaid our mortgage prior to maxing out 457 mainly because our interest rate was pretty high (and then did some of both, and then switched to not prepaying at all and only doing the 457 later in the mortgage when the benefits of prepayment were smaller and the mortgage was a smaller % of our net worth and thus less risky). Which you do first probably should depend on actually crunching the numbers for your specific situation.

      • SP Says:

        Ah, OK, makes sense! I’ve never heard of the CSS (which makes sense because I don’t have kids and went to a state university). You are right, home equity is included. This is useful to know. If/when we have kids, this could effect our long term strategies on mortgage pre-payment vs retirement. A back door Roth would also be more advantageous than mortgage prepayment.

        I’m quite certain about needing to wait until 70.5 years old to take out the money if you still work at the place that is offering a 457b. Other than that, a gov’t 457b seems ideal for flexibility. We already have sufficient assets in 401ks/IRA/403bs that we could access between 59.5 and 70.5 on the chance that T wants to remain employed at the same place until/beyond age 70.5. We have few assets we could access before 59.5.

        I still don’t like the cash flow implications of a large mortgage, even if there is a numerical advantage to funding a 457b and 403b before mortgage prepayments. Yet, if we have kids it probably does make sense to reduce prepayments, possible after 1 more year of reductions.

      • nicoleandmaggie Says:

        You must be right about the age of withdrawal. It is not easy to tell—they say you can tap it on retirement but don’t define retirement.

  8. SP Says:

    Also, I find these posts somewhat aspirational rather than obnoxious. My favorite blogs are more personal stories of how “normal” people are handling their money. Normal in quotes because I get the most out of the read the blogs of people who are fortunate to have quite a bit of means compared to the average, but who don’t aren’t pursing retirement at age 40. I suspect reading the average american’s PF blog would be… quite a bit more depressing.

  9. Debbie M Says:

    I don’t have any answers to your specific questions, but I have been thinking along similar lines because I think that besides college financial aid, money in retirement accounts may not count if you’re self-employed but then you or your company goes bankrupt and/or if one spouse gets sick enough to end up on Medicaid but you don’t want to leave the other spouse with nothing. I haven’t actually done much research on those scenarios, but if I get married, it could become relevant enough that I would want to.

  10. First Gen American Says:

    I have saved 20% for retirement for a long time. As I started earning more, 20% was above my pre-tax limit, so there was a little overflow of after tax $$ into my retirement savings. I’ve been back down to 15% for a while now but after reading this article, it’s food for thought to revisit this idea again. Not even sure if I can do this with my current employer’s 401K plan. At my part time Hotel chain, they only allow pre-tax 401K contributions which is a shame because I would have just put in my whole paycheck into the plan if there was an after tax matching funds option (I only work 2 hours a week there).

    I always assumed with 2 incomes, we wouldn’t qualify for much unless one or both of us is un or underemployed once college sets in. I’m surprised that the AGI’s are as high as they are so the numbers in my head are a little out of date. We’ve always been big believers of 1)retirement first, 2)then pay off house, 3)then save for education in that order.

  11. So we opened (taxed) traditional IRAs and Roth converted them | Grumpy Rumblings (of the formerly untenured) Says:

    […] decided to do this both for DH and for me this year.  With the tax bill, I got very worried about whether or not I’d be […]

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