Should I fund a non-deductible IRA

[socalsri]

I've read the wiki and a bunch of threads here and still can't come to a good conclusion. I'm not sure whether my wife and I should contribute 5K each to a non-deductible traditional IRA. We have consistently contributed to Roth IRAs every year, but this year we have the nice problem of making too much to qualify.

We max out 3 retirement accounts: 401k, 403b and 457, so that's a total of 49.5K and we save about the same amount in taxable. A backdoor Roth for me is probably out of the question because I have a larger rollover IRA that I can't rollover into my current 401k due to lack of investment choice there. My wife has about a 3K *deductible* traditional IRA account from years ago which we wouldn't mind converting to a Roth, so maybe we can do the backdoor Roth for her.

Here are what I see as the cons:

1. Already have a lot in tax deferred investments. Our asset allocation (60/40) doesn't call for us to have additional tax-deductible space for tax-inefficient investments
2. Is record keeping (besides form 8606) for wife's account a big deal since she'll have one deductible IRA and one non-deductible IRA? Both IRAs are (would be) at Vanguard.

Here are the pros:

1. Could possibly do a backdoor contribution in the future, at least for my wife
2. Doesn't hurt anything since I can always withdraw the contribution anytime without penalty and the earnings will be tax deferred.

Thanks!

[mhc]

I would pay the taxes and convert your wife's IRA to a Roth and do a backdoor Roth for her. The paperwork is not a big deal.

This will keep you from having to pay extra taxes on part of your investments. Most people would kill to have more tax sheltered space.

[jackpistachio]

Please explain further the lack of investment choices in your 401(k). What are the choices? Is there a PCRA option? Are in-service withdrawals allowed?

[DSInvestor]

Agree with mhc. do it for your wife but not for yourself if you're not rolling your IRA assets to 401k.

Will your wife's contribution be for tax year 2011 or 2012?

If 2011, her 2011 tax return must include form 8606 to track the non-deductible contribution. The conversion to Roth will have happened in calendar 2012 so that must be handled by your 2012 tax return also in form 8606. It's not difficult and if she converts all of her IRA (8K) to Roth, it will zero out the basis for 2012.

If you have sufficient cash, you can consider contributing another 5K non-deductible to Her Traditional IRA for 2012 at the same time as her 2011 contributions. This way you contribute 5K for 2011, 5K for 2012 and convert all 13K to Roth IRA. Easy.

For 2013, she'll have a clean slate, so she can contribute 5K and convert 5K to Roth anytime in 2013. If she contributes and converts in calendar 2013, her 2013 8606 will have 5K contribution and 5K contribution. Clean and easy.

[socalsri]

Thanks for all the replies.

DSInvestor, I should have mentioned that my concerns about a non-deductible IRA was for the 2011 year. To be honest, I think we should be able to contribute to a Roth for 2012 directly since our income will be lower.

jackpistachio, my 401k is with Fidelity. Not a whole bunch of choices, but more importantly, my AA is pretty well setup with the my rollover at VG, so it would requires changes to other accounts just to get our AA back in line.

[retiredjg]

In my opinion, there are two reasons to use a non-deductible traditional IRA.

-as the first step of a back door contribution to Roth IRA

-if you can't do back door, but do need more space for bonds or REIT

It seems the first reason might apply to your wife and that the second reason does not apply.

[arthurdawg]

I generally post funds to my traditional (and non-deductible) IRA and then convert to ROTH asap.

Speaking of which, how much longer are they going to allow the backdoor? Is it an option for this year?

[tfb]

DSInvestor, I should have mentioned that my concerns about a non-deductible IRA was for the 2011 year. To be honest, I think we should be able to contribute to a Roth for 2012 directly since our income will be lower.

If it's only for one year, it's your call whether you want to bother. For your wife, a non-deductible IRA converted to Roth still beats taxable.

[wander]

Other option is to invest in Tax-Managed mutual funds.

[555]

One rule of thumb:

For bonds, non-deductible traditional IRA is better than taxable.
For stocks, taxable is better than non-deductible traditional IRA.

As to a mixture of stocks and bonds in a traditional IRA, with a mixture of deductible and non-deductible contributions, I'll let someone else analyze that.

[larryc]

Records of non-deductible IRA's do tend to get lost. Be especially careful if your accountant changes tax programs.

[doublenickel]

We did non-deductible contribs to traditional IRAs for some years. Recently we were able to convert my wife's and pay a pittance of tax, so she has a bigger Roth going forward. I still contribute to my traditional (non-deductible) IRA to maintain some level of tax diversification - thinking who knows what the rules might be in the future!

[retiredjg]

I still contribute to my traditional (non-deductible) IRA to maintain some level of tax diversification - thinking who knows what the rules might be in the future!

So you can envision a scenario in the future where a non-deductible IRA is better than a Roth IRA? Or is it because you can't convert to Roth?

[doublenickel]

The pro-rata rule prohibits me from converting my TIRA; would trigger too much tax.

[retiredjg]

The pro-rata rule prohibits me from converting my TIRA; would trigger too much tax.

In that case, have you considered using a taxable account rather than a non-deductble IRA? It's probably a better choice unless you specifically need room for things that should not go into a taxable account.

[Default User BR]

The pro-rata rule prohibits me from converting my TIRA; would trigger too much tax.

Do you have a 401(k) or similar plan? Does it allow incoming rollovers from IRAs?


Brian

[doublenickel]

In that case, have you considered using a taxable account rather than a non-deductble IRA? It's probably a better choice unless you specifically need room for things that should not go into a taxable account.

We have taxable investments, too. As to TIRA, I am hoping - with future low-income years in my 60's - to convert as much of my TIRA as possible into my Roth w/ low tax bracket then. At least that's the plan...

[retiredjg]

In that case, have you considered using a taxable account rather than a non-deductble IRA? It's probably a better choice unless you specifically need room for things that should not go into a taxable account.

We have taxable investments, too. As to TIRA, I am hoping - with future low-income years in my 60's - to convert as much of my TIRA as possible into my Roth w/ low tax bracket then. At least that's the plan...

If you believe you will have some low income years, this sounds like a fine plan to me.

[doublenickel]

The pro-rata rule prohibits me from converting my TIRA; would trigger too much tax.

Do you have a 401(k) or similar plan? Does it allow incoming rollovers from IRAs?


Brian

No 401k, rolled it over to TIRA some years ago. I would do traditional contribs, then convert annually to Roth, like we're doing for my wife, but that's what would trigger the pro-rata rule (aggregating my existing TIRA) and thus lead to excessive taxes. See how I answered retiredjg above for future plan for TIRA.

[Cheap_rookie]

In my opinion, there are two reasons to use a non-deductible traditional IRA.

-as the first step of a back door contribution to Roth IRA

-if you can't do back door, but do need more space for bonds or REIT

It seems the first reason might apply to your wife and that the second reason does not apply.

That's why we have a non-deductable IRA (simlar stuation to the OP -- but with no likelihood of being below phaseout, at least until retirement.)

[555]

``

In my opinion, there are two reasons to use a non-deductible traditional IRA.

-as the first step of a back door contribution to Roth IRA

-if you can't do back door, but do need more space for bonds or REIT

It seems the first reason might apply to your wife and that the second reason does not apply.

That's why we have a non-deductable IRA (simlar stuation to the OP -- but with no likelihood of being below phaseout, at least until retirement.)''

It's not clear to me that REIT in non-deductable IRA is better than REIT in taxable. It depends on how the return is split between dividends and cap-gains. Have you analyzed this?

[grabiner]

It's not clear to me that REIT in non-deductable IRA is better than REIT in taxable. It depends on how the return is split between dividends and cap-gains. Have you analyzed this?

Wiki article link: Vanguard REIT Index Tax Distributions

REIT Index has been yielding about 4% in non-qualified dividends. In a 25% tax bracket, that is a tax cost of 1% per year, and you still pay 15% tax on the capital gains when you sell. It's better to pay 25% on all the gains and not pay taxes multiple times on reinvested distributions.

For example, suppose that returns are 8%, and the taxable dividend is 4%, which is 1% paid in tax and 3% reinvested. In 20 years in a taxable account, $10,000 will grow to $38,697, and $16,398 will be unrealized gains, with $2460 due in tax on the sale, so you will have $34,237. In 20 years in a non-deductible IRA, $10,000 will grow to $46,610, and you will pay 25% tax on the $36,610 gain, which is $9152, so you will have $37,468. The advantage of the IRA is even greater over a longer holding period.

Another benefit of the IRA is that you might choose to convert it to a Roth IRA in some future year; for example, you might be in a 15% tax bracket after you retire.

[555]

Okay, in the long run, tax on compounded dividends is more significant than the higher tax rate on capital gains. It could be reversed for shorter time periods, or if there are high capital gains. The point is, people need to think it through.

[Cheap_rookie]

Yep ... per Grabiner post above, REIT in IRA was better, especially since we are at/near 33% threshold and really close to AMT