Nondeductible IRA -- bad idea?

[audreyh1]

A (sort of) thought experiment regarding taxable versus tax-deferred IRAs.

Back in the early to mid 1990s we purchased granted incentive stock options. Most of us purchased with after tax funds, so these became part of our retirement portfolio.

But one older colleague somehow swung it to purchase his stock options through an IRA. He must have had a rollover IRA from a previous job in a brokerage account, but I think it still took considerable finagling to pull that off.

We paid no taxes as our company stock appreciated considerably because it was all unrealized gain. It ultimately grew enough to retire early.

Later, as we got ready to retire we finally started to diversify that stock. We paid a straight 20% at first, then later 15%, and still hold some of the original investment. We are in the 15% tax bracket, pay 0% on some of our cap gains/qualified dividends, we get hit with a little AMT at times due to a high amount of cap gain/qualified dividend income but still our effective tax rate stays well below 15% overall.

But my colleague who retired before I did, must have had to set up a 72T once he needed to draw on those funds. And then he would have been paying ordinary income rates on his withdrawals. One day he'll have to take RMDs.

I sometimes wonder whether he was glad he finagled to purchase in his IRA, or wished he hadn't. I know that later I was just fine with things being taxable, but initially I assumed he was making a very smart move.

I simply don't know enough about his case to really know.

 

[pb4uski]

During your earning years, was your income low enough that you qualified to contribute to deductible IRAs or Roth IRAs? Are those what make up your deferred accounts?

Some deductible IRAs early in my career, but most my tax-deferred is from 401ks over the course of my career during my higher earning (and higher taxed) years.

Roths came into play later on once I went part time and are only 8% of the total.

 

[youbet]

I simply don't know enough about his case to really know.

That seems to be the bottom line. Based on comments in the thread, it seems individual circumstances dictate whether a non-deductible IRA works out favorably or not. I funded non-deductible IRA's for a number of years many years ago. I invested in interest bearing instruments which seemed like a good buy at the time and just let things compound, tax shrinkage free, over the years. Now FIRE'd and in a lower tax bracket, I'm doing some Roth conversions and anything not converted will be part of upcoming RMD's, along with my 401k.

It is possible that I could have invested this money in a taxable account, picked the right investments and actively managed for tax efficiency and done better. But I wanted a small percentage of my portfolio sitting in conservative, interest bearing instruments that required little intervention and had zero impact on my taxes. In retrospect, the non-deductible IRA strategy seems to have worked out well in my circumstances.

Today I fund a non-deductible IRA for my son. I wanted to have a place to do some recreational short term trading and for trying some new investment strategies I've been trying to learn. He opened the account, got me POA and the password and I fund and trade it. There is no impact on his taxes, no paperwork for him to worry about other than including an 8606 with his taxes every year, a five minute (at most) job. So far, it's been great fun, I've enjoyed having a few bux involved in short term trading and I've learned some new things.

OTOH, some of the other posters have shared taxable account strategies that are working out well for them in their individual and different strategies.

So maybe the answer is "it depends."

 

[mathjak107]

a non deductable ira would be very similiar to using an annuity in a taxable account.

the lower capital gains rates from just buying equities in your taxable account will beat the tax deferred growth and paying regular tax rates generally.

the newsletter i subscribe to just did a comparison of their growth model which uses fidelity funds vs their annuity model utilizing the same or closest funds .

100k invested 20 years ago worked out to be about 50k more utilizing writeoffs and lower capital gains rates in the taxable account than the deferred annuity taxed at regular rates assuming a 25% tax bracket, the after tax balances were 367k for the growth model vs 309k for the tax derred annuity model. ...the fidelity annuity products do carry a slightly higher expense fee so some oif the difference is a bit of expense difference too.

 

[youbet]

a non deductable ira would be very similiar to using an annuity in a taxable account.

.

Actually, that's not true. Annuities do not allow you to trade individual positions and have higher fees.

 

[mathjak107]

Actually, that's not true. Annuities do not allow you to trade individual positions and have higher fees.

you certainly can trade positions , fidelity has a whole selection of vip funds.

you can change any time you want.

I already mentioned the higher fees although they are not to bad in fidelity.

 

[meierlde]

Actually, that's not true. Annuities do not allow you to trade individual positions and have higher fees.

I believe the post was referring to the tax treatment only. Which is then true you get some of the annunity as return of capital which is not taxed and some as income which is taxed. Now the issue of what you invest in and fees are different issues.

 

[youbet]

I believe the post was referring to the tax treatment only. Which is then true you get some of the annunity as return of capital which is not taxed and some as income which is taxed. Now the issue of what you invest in and fees are different issues.

What we are investing in is the key thing for us. We are using the non-deductible IRA for short term recreational trading and it has advantages over a taxable account for that purpose. And an annuity would not allow the trading at all.

 

[youbet]

you certainly can trade positions , fidelity has a whole selection of vip funds.

you can change any time you want.

I already mentioned the higher fees although they are not to bad in fidelity.

Trade individual equities, not funds.

Sorry if I was not clear.