Roth vs. stock

[GrayHare]

Annually around this time I struggle with the IRA funding decision. Several years ago it finally dawned on me that non-tax deductible contribs to a Traditional IRA are a bad idea because upon distribution they will be taxed at ordinary income rates. It's smarter to instead buy a stock to hold long-term: upon sale the capital gains tax rate will apply, which for me I project will be lower than the ordinary income rate after FIRE.

But when it comes to Roth IRAs, I'm not sure the numbers tilt the same way. The only IRA contrib for which I qualify is the non-tax deductible Traditional type, but immediately after the contrib I can convert it to Roth. The question becomes: does it make sense to pay tax on the contrib at ordinary rates now so as to gain the benefit of non-taxable growth inside the Roth, or it is better to simply dump the same post-tax amount into a stock to hold long term?

 

[kaneohe]

Do you have other existing deductible IRAs? If you don't, seems like you would pay the same amount of tax on the income you use to fund the non-deductible TIRA and the stock. When you convert the non-deductible to Roth, you wouldn't pay any additional taxes if you had no other deductible IRAs. In this case, the Roth would have no further taxes upon withdrawal assuming you followed the rules on age,etc but the stock would still be subject to capital gains so Roth should win.

If you had other deductible IRAs, you would be taxed to some or a large extent on the Roth conversion so depending on your tax bracket when making the contribution vs the capital gains tax rate when you sell the stock, it would seem like it could go either way. If your current bracket were much higher than the future capital gains rate, that would favor the stock . If the rates were similar, there might not be much difference.

 

[GrayHare]

Thanks for your reply, kaneohe. I have no deductable IRAs dollars left (converted all TIRA to Roth in 2010). So my choice now for new contribs is either Roth (via a temporary TIRA) or long-term stock; since both will be funded with post-tax dollars, it seems the Roth is the clear winner, though I worry I've missed considering some factor.

 

[Lsbcal]

...(snip)... The question becomes: does it make sense to pay tax on the contrib at ordinary rates now so as to gain the benefit of non-taxable growth inside the Roth, or it is better to simply dump the same post-tax amount into a stock to hold long term?

A lot depends on the your future plans. For instance, suppose you will retire at 55 and have a low taxable income until SS kicks in. In this case you might want to make the Roth conversion during the low taxable income stage. Of course, we don't know precisely about future tax rates. They will probably go up. Will a flat tax be adopted? I'd bet not but that would really change things.

So I think some of this depends on how far out your retirement is and on some of the details of your income flow and tax bracket.

 

[kaneohe]

A lot depends on the your future plans. For instance, suppose you will retire at 55 and have a low taxable income until SS kicks in. In this case you might want to make the Roth conversion during the low taxable income stage. Of course, we don't know precisely about future tax rates. They will probably go up. Will a flat tax be adopted? I'd bet not but that would really change things.

So I think some of this depends on how far out your retirement is and on some of the details of your income flow and tax bracket.

OP will not pay anything for conversion since contribution is non-deductible.
If OP does not contribute now, there will be nothing to convert so opportunity will have been lost.

 

[LOL!]

Isn't that kind of a weird question?

Do you want to
(a) pay tax now and pay cap gains tax later?
-or-
(b) pay the same tax now and pay no tax later?

I choose (b). Furthermore, with (a) you will be taxed also on any dividends that are paid over the life of your investment. With (b) you can invest in stocks and bonds and get even the ordinary dividends tax-free.

To be clear, option (b) is contribute to tIRA and convert immediately (same day or next day) to Roth IRA.

 

[GrayHare]

For those with no tax-deductable IRA option, so far I can find no downside to Roth relative to any other savings approach with the same after-tax dollars. My basic assumption (perhaps flawed) is for the next few decades US tax structure will remain more or less the same as present. I've chosen to not worry about how future tax structure might differ: so many changes could be invented there's no way to anticipate and plan for them all.

 

[Lsbcal]

Sorry, I misunderstood and was thinking of a deductible IRA -> Roth conversion. Scratch my ideas there.

 

[jIMOh]

Isn't that kind of a weird question?

Do you want to
(a) pay tax now and pay cap gains tax later?
-or-
(b) pay the same tax now and pay no tax later?

I choose (b). Furthermore, with (a) you will be taxed also on any dividends that are paid over the life of your investment. With (b) you can invest in stocks and bonds and get even the ordinary dividends tax-free.

To be clear, option (b) is contribute to tIRA and convert immediately (same day or next day) to Roth IRA.

This was my initial reaction.

Better to be tax free inside the Roth than paying capital gains taxes outside the Roth (which are subject to change with change in tax code).

I also second the comment which states money in a traditional IRA can be converted, money in a non qualified account cannot be converted.

The main advantage to taxable accounts is high liquidity with low penalty. Much of that liquidity could exist in a Roth if the 5 year rule was met.

 

[Animorph]

If you can put up with the restrictions, the Roth should be much better than a taxable account, however you get there. I like the deductable IRA/401k a little better if you can convert later using a much lower tax bracket, but that's not available to you. The Roth will be better than leaving non-deductable contributions in a traditional IRA.

 

[Chuckanut]

Lots of good advice here. I have to consider converting some $$'s to a Roth when I retire and my taxable income goes down.