Nondeductible IRA -- bad idea?

[youbet]

I'm not a fan of non-deductible IRAs. I would prefer taxable myself.

How about deductiblle IRAs if your income is low enough to qualify?

Or 401k beyond the match?

 

[LOL!]

I don't understand people thinking it was a big investing mistake. My IRA was all in a small cap stock fund and is now like 6x the cost basis.

If you had invested the same way in a taxable account instead of the non-deductible IRA, then the small cap stock would still be now like 6x the cost basis. But what is going to be the difference in taxes when you need to spend the money?

It is possible that you will be able to withdraw from the non-deductible IRA while in a very very low tax bracket, but that would also mean that you could withdraw from a taxable account and take long-term cap gains at 0%. Years ago, there was not the 0% LT cap gains "bracket", but it has always been that LT cap gains are taxed at a lower rate than ordinary income.

Furthermore, tax-loss harvesting is pretty hard to do in an IRA.

 

[jetpack]

I believe that you have to fill out Form 8606 for non deductible ira contributions from now to eternity. My friend got messed up in that and is now sorry. Luckly, on a few years before retirement for him.

 

[pb4uski]

How about deductiblle IRAs if your income is low enough to qualify?

Or 401k beyond the match?

Fine with both since they can defer ordinary income.

I prefer taxable over non-deductible IRA since income is tax at lower than ordinary rates and I prefer that over just deferral of income but conversion of income from preferential rates to ordinary rates.

 

[Fermion]

Non deductible IRA has an advantage that you can convert it to a Roth if at some point you have a low income. You can never convert taxable to Roth.

Say you had a non deductible IRA with a basis of $30,000 that has grown to $80,000. If you are retired and living off of dividends plus some cash (maturing CDs, etc) you may be able to convert $25,000 a year of the IRA to Roth and pay no tax at all. $25,000 x 5/8 = $15,625 which still leaves about $4400 you could have in interest and pay no tax for a married couple ($20,000 in deductions and personal exemptions). You could have dividends and capital gains of an additional $20,000 or more and still pay no tax.

 

[youbet]

Fine with both since they can defer ordinary income.

I prefer taxable over non-deductible IRA since income is tax at lower than ordinary rates and I prefer that over just deferral of income but conversion of income from preferential rates to ordinary rates.

If you're holding one of those Penn Fed 3% CD's in your taxable account, how do you pay less than "ordinary rates" on the interest?

 

[JoeWras]

I believe that you have to fill out Form 8606 for non deductible ira contributions from now to eternity. My friend got messed up in that and is now sorry. Luckly, on a few years before retirement for him.

If you use turbotax it is no big deal.

I have a portion non-deductible. I'm OK with it. I plan on roth conversions later and will have to pro-rate. I think I can handle the math.

I put all my REITs in this IRA.

 

[youbet]

If you use turbotax it is no big deal.

I have a portion non-deductible. I'm OK with it. I plan on roth conversions later and will have to pro-rate. I think I can handle the math.

I put all my REITs in this IRA.

+1

Doing form 8606, including figuring pro-rata withdrawals for either spending or Roth conversions is a no-brainer. Years ago, I fretted over it thinking I'd need a team of CPA's. When I actually did it, it was quick and simple.

Of the various things to keep track of with FIRE finances, the basis of either TIRA's or Roth IRA's is one of the easiest. I don't know where folks get the idea it's going to be some sort of "nightmare."

 

[Bogie]

Fermion, If your earned income with some deductions is below about $188,000 for married filing jointly you can move $6500 each if you are 50+. So there is a way to move taxable with limits. All gains will forever be "tax-free" unless they change the rules.

I copied this from "Fox Business"
"
Roth limited for income:

• $178,000 to $188,000 for married couples filing jointly in 2013; $181,000 to $191,000 for the 2014 tax year.
• $112,000 to $127,000 for single or head of household taxpayers or married couples filing separately and who did not live with their spouse in 2013; $114,000 to $129,000 for 2014 filings.
• Zero to $10,000 for married couples filing separately who lived together at any time during either the 2013 or 2014 tax year.

 

[Fermion]

Fermion, If your earned income with some deductions is below about $188,000 for married filing jointly you can move $6500 each if you are 50+. So there is a way to move taxable with limits. All gains will forever be "tax-free" unless they change the rules.

If you have earned income. If you are retired and living off of your portfolio/cash, you probably will not have earned income.

 

[Bogie]

Exactly. If at least one person has enough earned income you can contribute up to the max in the Roth. I don't see why anyone with earned income wouldn't be moving their taxable account to the Roth if they are within the earned income limits other than the 5 year rules. Roth income is the only income that I know of that doesn't affect the taxation of Social Security.

I recently retired but wife is still working so I sometimes overlook the earned income caveat.

 

[JoeWras]

Of the various things to keep track of with FIRE finances, the basis of either TIRA's or Roth IRA's is one of the easiest. I don't know where folks get the idea it's going to be some sort of "nightmare."

+1 too!

What gives me heartburn at tax time is some of the off-the-program calculations I have to do to get my max benefit on the state form. You know, some of the mutual funds have a percentage of income derived from treasuries. And then the muni fund has a percentage of munis from my state. I could blow this off, but it is to my advantage to calculate these out. Turbotax is not a great help for this.

But now that I have spreadsheet for that it isn't too bad either, just a pain that is tolerable. A similar amount of pain will proceed when I have to do my pro-rata distributions or rollovers some day.

 

[38Chevy454]

Non deductible IRA has an advantage that you can convert it to a Roth if at some point you have a low income. You can never convert taxable to Roth.

Say you had a non deductible IRA with a basis of $30,000 that has grown to $80,000. If you are retired and living off of dividends plus some cash (maturing CDs, etc) you may be able to convert $25,000 a year of the IRA to Roth and pay no tax at all. $25,000 x 5/8 = $15,625 which still leaves about $4400 you could have in interest and pay no tax for a married couple ($20,000 in deductions and personal exemptions). You could have dividends and capital gains of an additional $20,000 or more and still pay no tax.

Fermion, If your earned income with some deductions is below about $188,000 for married filing jointly you can move $6500 each if you are 50+. So there is a way to move taxable with limits. All gains will forever be "tax-free" unless they change the rules.

I copied this from "Fox Business"
"
Roth limited for income:

• $178,000 to $188,000 for married couples filing jointly in 2013; $181,000 to $191,000 for the 2014 tax year.
• $112,000 to $127,000 for single or head of household taxpayers or married couples filing separately and who did not live with their spouse in 2013; $114,000 to $129,000 for 2014 filings.
• Zero to $10,000 for married couples filing separately who lived together at any time during either the 2013 or 2014 tax year.

Exactly. If at least one person has enough earned income you can contribute up to the max in the Roth. I don't see why anyone with earned income wouldn't be moving their taxable account to the Roth if they are within the earned income limits other than the 5 year rules. Roth income is the only income that I know of that doesn't affect the taxation of Social Security.

I recently retired but wife is still working so I sometimes overlook the earned income caveat.

Can someone confirm my logic please? I agree with these posts above. If the money is after-tax when you put it in, there seems to be no reason for a non-deductible IRA. A Roth IRA will also grow tax free, and then you have no tax liability in the end. The non-deductible IRA still has the tax liability on the portion that is the growth. My logic is same amount going in as after tax money, but one has additional withdrawal tax liability and one does not.

So why would you not use a Roth IRA instead of the non-deductible IRA? Both are IRA accounts, so you do have the money with withdrawal limits before you reach age 59.5 or retirement with 72T. I fully understand a regular taxable account instead so you can have access anytime you need. To me it is foolish to pay more in taxes by one choice non-deductible IRA vs the other choice Roth IRA.

I realize that you have to be below the income limits, so for some it may not be an option.

 

[Fermion]

I realize that you have to be below the income limits, so for some it may not be an option.

That answers your whole question. There is zero, nada, zilch reason to put money into a non-deductible traditional IRA if you are able to directly contribute to a Roth IRA. Some people make more than $190,000 a year.

Ok, that didn't take long. I did think of a way out scenario where you may have wanted to contribute to a traditional IRA instead of a Roth.

Say you have $100,000 in capital losses from previous years. You have a portfolio of losers where anything you sell is going to just be another loss. Your dividend and interest income are not enough to bring your MAGI up to $21,000 to qualify for a subsidized silver ACA plan. If you have some traditional IRA money however, you can convert that into a Roth IRA and use that to bump your MAGI high enough that you qualify for a subsidized silver plan. This could save you quite a bit of money and you still wouldn't pay any tax.

I told you it was way out there though.

 

[youbet]

So why would you not use a Roth IRA instead of the non-deductible IRA?

We are discussing contributing to a non-deductible IRA when your income does not allow you to either deduct a TIRA contribution or to contribute to a Roth IRA.

 

[kaneohe]

Thanks for all the comments. I think I will avoid the non deductible ira for now.

This seems like a rather surprising conclusion since nothing that has been said contradicts the fact that using the non-deductible IRA for ordinary income investments and deferring tax from high to lower rates is not a bad idea if you have no more space to put the ordinary income investment in other more tax-favored vehicles. Different story for efficient capital growth vehicles but that's not was spec'd in OP.

 

[GrayHare]

Many who earn too much to qualify for a deductible tIRA or Roth will not be in a lower tax bracket after retirement, especially if they reuse dryer sheets and save the high % of income that many here do.

 

[pb4uski]

If you're holding one of those Penn Fed 3% CD's in your taxable account, how do you pay less than "ordinary rates" on the interest?

I don't hold any fixed income in my taxable account. All fixed income (including the Pedfed CD) is in tax-deferred accounts where it is deferred ordinary income.

My taxable account is domestic equities that generate tax free qualified dividends and some international equities that generate dividends that are partially qualified and also provide me with a credit for foreign taxes paid and both provide me with tax free capital gains.

My effective federal tax rate on my taxable account investment income and capital gains last year was 2.2% (taxes/income with/without taxable account dividends and capital gains).

 

[audreyh1]

If you had invested the same way in a taxable account instead of the non-deductible IRA, then the small cap stock would still be now like 6x the cost basis. But what is going to be the difference in taxes when you need to spend the money?

Not really, because the fund does pay out income and capital gains distributions most years, so I don't think it would be 6X. Something smaller because of tax drain.

 

[audreyh1]

Many who earn too much to qualify for a deductible tIRA or Roth will not be in a lower tax bracket after retirement, especially if they reuse dryer sheets and save the high % of income that many here do.

Not true in my case at all. Income characteristics can change drastically when it comes from investments instead of salary and so tax brackets can drop big time.

 

[Alan]

Not true in my case at all. Income characteristics can change drastically when it comes from investments instead of salary and so tax brackets can drop big time.

+1

Especially with two incomes for a married couple. Our marginal tax band dropped significantly when we retired. I then did ROTH conversions on our non-deductible IRA's, and was taxed only on the gains. The following year I rolled over our before tax 401k's to Rollover IRA's

 

[LOL!]

Not really, because the fund does pay out income and capital gains distributions most years, so I don't think it would be 6X. Something smaller because of tax drain.

Ah, I see. I guess it was a tax-efficient fund then.

 

[audreyh1]

Ah, I see. I guess it was a tax-efficient fund then.

I guess not super tax efficient as it did pay out distributions most years, sometimes substantial. But not as tax inefficient as an income fund or bonds.

 

[kaneohe]

Many who earn too much to qualify for a deductible tIRA or Roth will not be in a lower tax bracket after retirement, especially if they reuse dryer sheets and save the high % of income that many here do.

OP hints , though admittedly does not say explicitly, that bracket will be lower later: (from OP) "Instead, I was wondering whether there might be some advantage to save highly taxable funds, like bond funds or reit funds in a non-deductible IRA to avoid getting 1099's from these investments during my high tax-bracket years (now)."

 

[youbet]

I don't hold any fixed income in my taxable account. All fixed income (including the Pedfed CD) is in tax-deferred accounts where it is deferred ordinary income.

My taxable account is domestic equities that generate tax free qualified dividends and some international equities that generate dividends that are partially qualified and also provide me with a credit for foreign taxes paid and both provide me with tax free capital gains.

My effective federal tax rate on my taxable account investment income and capital gains last year was 2.2% (taxes/income with/without taxable account dividends and capital gains).

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?