From Bogelheads we read Any value in non-deductible IRA?
by ThatFella » Mon Sep 09, 2013 1:42 pm
Hi all,
This is my first time posting, but I have been lurking for a long time, and wanted to say that you all have been tremendously helpful between these forum posts and the wiki. Thanks for all you do!
Emergency funds: Done
Debt: Only mortgage (30 yrs @ 4.25%), over-paying the minimum each month
Tax Filing Status: Married filing jointly
Tax Rate: 33% Federal
State of Residence: IL
Age: 30
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 33% of stocks
The wife and I have maxed out our employer 401ks and have a significant amount beyond a retirement fund in a savings account. I’m looking to begin investing much of that beyond the 401k.
My understanding is that we are not eligible to invest in a Roth IRA because we exceed the $188K limit for Roths. My understanding is also that we will get no tax deduction using a traditional IRA because our AGI exceeds the $112K limit.
Is there still value in contributing and maxing out the traditional IRA without the deductions, or is it now equivalent to investing in a taxable account? More generally, what is the benefit of a traditional IRA if you do not get the deduction up-front? I read that “at least your savings will grow tax-deferred”, but I’m not clear if/how this is different from what would happen in a taxable account. In fact, wouldn’t my taxes potentially be higher at withdrawal in retirement since it will be at my regular tax rate versus the lower capital gains rate? Should I skip the IRA altogether? Am I missing other options?
Thanks in advance!
This is my first time posting, but I have been lurking for a long time, and wanted to say that you all have been tremendously helpful between these forum posts and the wiki. Thanks for all you do!
Emergency funds: Done
Debt: Only mortgage (30 yrs @ 4.25%), over-paying the minimum each month
Tax Filing Status: Married filing jointly
Tax Rate: 33% Federal
State of Residence: IL
Age: 30
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 33% of stocks
The wife and I have maxed out our employer 401ks and have a significant amount beyond a retirement fund in a savings account. I’m looking to begin investing much of that beyond the 401k.
My understanding is that we are not eligible to invest in a Roth IRA because we exceed the $188K limit for Roths. My understanding is also that we will get no tax deduction using a traditional IRA because our AGI exceeds the $112K limit.
Is there still value in contributing and maxing out the traditional IRA without the deductions, or is it now equivalent to investing in a taxable account? More generally, what is the benefit of a traditional IRA if you do not get the deduction up-front? I read that “at least your savings will grow tax-deferred”, but I’m not clear if/how this is different from what would happen in a taxable account. In fact, wouldn’t my taxes potentially be higher at withdrawal in retirement since it will be at my regular tax rate versus the lower capital gains rate? Should I skip the IRA altogether? Am I missing other options?
Thanks in advance!
- ThatFella
- Posts: 2
- Joined: 9 Sep 2013
Re: Any value in non-deductible IRA?
by Spirit Rider » Mon Sep 09, 2013 4:10 pm
I know of two possible uses for a non-deductible IRA.
The first involve the use of the "backdoor" ROTH IRA. This allows you to contribute to a non-deductible IRA and then immediately convert to a Roth IRA. This can be done without regard to income.
This must be done proportional to all traditional IRA balances. So if you have substantial IRA balances this may not be beneficial because a high percentage of your conversion may be taxable and you are already at a very high marginal tax rate.
However, you could roll all your current IRA balances into your 401k accounts. Then you would have no pre-tax balances in your IRAs. This would allow all backdoor Roth rollovers to proceed essentially tax free.
The other case would be a very unusual circumstance given your asset allocation. If you had substantial taxable balances invested in tax efficient assets. Also, you had insufficient room in your tax advantaged accounts for tax inefficient assets to meet your asset allocation. Then the non-deductible IRA would provide more room to deferr the taxes on additional tax inefficient assets.
The first involve the use of the "backdoor" ROTH IRA. This allows you to contribute to a non-deductible IRA and then immediately convert to a Roth IRA. This can be done without regard to income.
This must be done proportional to all traditional IRA balances. So if you have substantial IRA balances this may not be beneficial because a high percentage of your conversion may be taxable and you are already at a very high marginal tax rate.
However, you could roll all your current IRA balances into your 401k accounts. Then you would have no pre-tax balances in your IRAs. This would allow all backdoor Roth rollovers to proceed essentially tax free.
The other case would be a very unusual circumstance given your asset allocation. If you had substantial taxable balances invested in tax efficient assets. Also, you had insufficient room in your tax advantaged accounts for tax inefficient assets to meet your asset allocation. Then the non-deductible IRA would provide more room to deferr the taxes on additional tax inefficient assets.
- Spirit Rider
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- Joined: 2 Mar 2007
Re: Any value in non-deductible IRA?
by 123 » Mon Sep 09, 2013 4:18 pm
The advantage of a non-deductible IRA is that the growth of assets in the account (either from dividends, interest, or capital appreciation) is not taxed until funds are withdrawn from the IRA. This growth provides a significant advantage the longer the funds remain in the IRA. Since no tax reporting is necessary when you sell or trade assets within an IRA it can be an exceptionally easy way to handle brokerage investments. However, if one is a long-term buy and hold investor the regular capital gain tax provisions may provide a lower tax rate because distributions (of porportionate gains) from a non-deductible IRA will be taxed as ordinary income. Depending on an individual's age and assets one might decide that having a mix of accounts, each with different tax scenarios could provide more options. Down the road considerations could also include the potential role of the account in charitable gifting as well as estate planning. Since IRAs have a comparatively low maximum contribution each year it may take time to build the account up to a useful size but trading within an IRA without immediate tax consequences feels really good.
I agree with Spirit Rider that currently the most significant advantage of a non-deductible IRA is that it provides an opening to the "backdoor" ROTH IRA.
I agree with Spirit Rider that currently the most significant advantage of a non-deductible IRA is that it provides an opening to the "backdoor" ROTH IRA.
The closest helping hand is at the end of your own arm.
- 123
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- Joined: 12 Oct 2012
Re: Any value in non-deductible IRA?
by ThatFella » Mon Sep 09, 2013 6:21 pm
Thank you, Spirit Rider and 123!
I've been reading up on the "backdoor" ROTH, and that looks like the thing to do! I do not have any non-Roth deductible IRA contributions currently, so that should make that process fairly smooth. Do you have any thoughts on the "waiting" period between contributing and converting converting that I've read about?
I want to make sure I understand 123's point correctly. Anything invested in the IRA can be moved around and reconfigured within the IRA at any time without having any tax consequences. However, if you were to move around assets in a taxable account, the trade would be seen as a withdrawal and you would pay the capital gains (or other tax impacts) at that time. Is that right?
I've been reading up on the "backdoor" ROTH, and that looks like the thing to do! I do not have any non-Roth deductible IRA contributions currently, so that should make that process fairly smooth. Do you have any thoughts on the "waiting" period between contributing and converting converting that I've read about?
I want to make sure I understand 123's point correctly. Anything invested in the IRA can be moved around and reconfigured within the IRA at any time without having any tax consequences. However, if you were to move around assets in a taxable account, the trade would be seen as a withdrawal and you would pay the capital gains (or other tax impacts) at that time. Is that right?
- ThatFella
- Posts: 2
- Joined: 9 Sep 2013
Re: Any value in non-deductible IRA?
by pingo » Mon Sep 09, 2013 6:29 pm
^ Moving funds/money around inside any IRA is not a taxable event, just like your 401k.
- pingo
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- Joined: 19 Sep 2009
Re: Any value in non-deductible IRA?
by DSInvestor » Mon Sep 09, 2013 7:06 pmThatFella wrote:I do not have any non-Roth deductible IRA contributions currently, so that should make that process fairly smooth.
Do you have any pretax assets in any other iRA accounts like Rollover-IRA, Traditional-IRA, SEP-IRA, SIMPLE-IRA? If you have a rollover IRA from an old 401k that could complicate the conversion step of backdoor into Roth IRA. See IRS form 8606 lines 1-15 for details. Notice that line 6 asks for the value of traditional' SEP, simple iras as of dec 31.
http://www.irs.gov/pub/irs-pdf/f8606.pdf
- DSInvestor
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Re: Any value in non-deductible IRA?
by grabiner » Mon Sep 09, 2013 7:27 pmThatFella wrote:Thank you, Spirit Rider and 123!
I've been reading up on the "backdoor" ROTH, and that looks like the thing to do! I do not have any non-Roth deductible IRA contributions currently, so that should make that process fairly smooth. Do you have any thoughts on the "waiting" period between contributing and converting converting that I've read about?
There is no need to wait, and if you do wait and have gains, you would need to pay tax on them, so you might as well convert the day your deposit is available. You can either invest in a mutual fund in the non-deductible IRA and then convert to the same fund in the Roth, or else invest in a money-market fund in the non-deductible IRA and then convert to the fund you want to hold in the Roth.
I want to make sure I understand 123's point correctly. Anything invested in the IRA can be moved around and reconfigured within the IRA at any time without having any tax consequences. However, if you were to move around assets in a taxable account, the trade would be seen as a withdrawal and you would pay the capital gains (or other tax impacts) at that time. Is that right?
Yes, this is how taxes work, which is the advantage of the IRA.
David Grabiner
grabiner- Advisory Board
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Re: Any value in non-deductible IRA?
by pingo » Mon Sep 09, 2013 7:43 pm
I realize OP has already been studying about the Backdoor Roth, but the usual links haven't been referenced in this thread, so I'll post 'em in case they're helpful to the OP or lurkers:
The Backdoor Roth: A Complete How-to
Bogleheads.org Wiki: Backdoor Roth IRA
Oh, I hadn't seen this one yet:
How to Report Backdoor Roth in TurboTax
The Backdoor Roth: A Complete How-to
Bogleheads.org Wiki: Backdoor Roth IRA
Oh, I hadn't seen this one yet:
How to Report Backdoor Roth in TurboTax
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