IRAs with no deductions

[NinjaPigeon]

Is it worth funding a traditional IRA if you don't get the deductions? The reason I'm asking is because

-I contribute max % per paycheck to my 401k
-I'm not eligible for a Roth this year
-I already put after-tax money into a brokerage account with Vanguard

The main benefit I see that's making me consider funding the IRA is that it'll be tax deferred. That allows me to get more money invested early, which over my 30 year investment horizon means more on the backend due to compounding, even if I'm in the same tax bracket.

On the other hand, I already contribute after tax to my brokerage accounts, which I can tap into at any time without paying a federal penalty. Also, I read about the rules for converting an IRA to a Roth, and even though I'd have paid all tax on that IRA prior to a conversion, I'd end up owing more tax because they look at the total value of all IRA accounts to determine tax at conversion. (I can't remember the link I read this on, but they gave an example and used a funny word to describe how the government justifies this sneaky taxing of already taxed money)

 

[LOL!]

I do not think it's worth contributing to a non-deductible traditional IRA. 

That written, I have such a beast.  I thought that I would use it to trade with impunity and not to have to worry about the tax consequences.  The reality is that it doesn't work.  First, though your realized gains are not immediately taxed, your realized losses don't get you a tax break either.  Second, the amount of money you can contribute to the IRA is limited.  It was something like $2K a year when I was making contribution, though the amount is larger now.  That amount is really not enough to make a significant impact when measured against my other accounts.  That has to go for you as well because you have high income as evidenced by ineligibility for a Roth and maxing your 401(k).

So I have put my non-deductible traditional IRA into set it and forget mode: it has DODFX in it and nothing else.

But my after-tax investing is also set it and forget it.  That means that I rarely, if ever, realize any capital gains, so that  my taxable investing has generated no capital gains taxes in 3 years.  This is mostly because of two reasons;  (1) I also book my losers annually and use those losses to offset the gains dribbled about by some mutual funds. (2) I use ETFs, funds that do not put out much in the way of capital gains as well as a smattering of stocks that I don't trade, like MO.

The IRA gains will eventually be taxed as income taxes; the after-tax account gains are taxed at the lower capital gains tax rate.  Just that alone says why bother with a non-deductible IRA?

As for Roth conversion.  I have plenty of 403(b) and 401(k) assets that will eventually get rolled over into an IRA, so I will have plenty of conversion opportunity.

Bottom line: do not do a non-deductible traditional IRA, but invest in a tax-managed way in an after-tax account.  It's the same amount of money going in, but lower taxes coming out.

 

[youbet]

I'll give the alternative view point........

I funded non-deductable IRA's for DW and myself for a number of years.  They've been a convenient place to hold the interest bearing portion of our portfolio such as CD's, bond funds, etc. and enjoy tax deferred compounding.  We understand that withdrawals will be taxed as ordinary income, but we'll be in a low tax bracket in retirement.

If you're still young and can enjoy a long period of compounding, and if you feel your retirement tax bracket will be lower than your current tax bracket, non-deductible IRA's can still make a lot of sense.

 

[NinjaPigeon]

Well I'm in the 28% bracket now. Given that the norm SWR seems to be 4%, and assuming a modest retirement account of 1 mil, that would land me in the 25% bracket. Not much of a difference really - just $1200/year.

Though it looks like I might end up in the 33% bracket if I get married (since I will most likely file separately). In that case, the difference is a bit more noticable at $3200/year.

 

[LOL!]

I'll give the alternative view point........

I funded non-deductable IRA's for DW and myself for a number of years.  They've been a convenient place to hold the interest bearing portion of our portfolio such as CD's, bond funds, etc. and enjoy tax deferred compounding.  We understand that withdrawals will be taxed as ordinary income, but we'll be in a low tax bracket in retirement.

If you're still young and can enjoy a long period of compounding, and if you feel your retirement tax bracket will be lower than your current tax bracket, non-deductible IRA's can still make a lot of sense.

If you will be in a low tax bracket in retirement, then your capital gains tax rate will be even lower.

I use my other tax-deferred accounts such as 403(b) and deductible IRAs from years ago for the fixed income assets and relatively high dividend paying stocks, so I do not need a non-deductible IRA for that.

We are also in the 28% tax bracket now, but will drop below the 25% bracket in retirement. Note that in the 28% tax bracket, the Vanguard Tax-exempt money market fund is better than the Vanguard Prime MMF as far as "after-tax" return.

 

[Alan]

I also fund a traditional IRA.  The majority of my bonds are in tax deferred accounts.  I only put money in after max'ing out on 401(k).

I have no mortgage or other debt, but when I did I was more choosy about where to put extra money.