Why should I contribute to my non-deductible IRA?

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Sam-I-Am-Not
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Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

With income too high to contribute directly to a Roth IRA or to take a tax deduction for my contribution to my traditional IRA account, should I not bother? I am about 10 years from retirement and have ample funds to retire. For 2021 should I place $7,000.00 in my taxable account as an index 500 ETF resulting in me earning about 2% qualified dividend yield per year and having to pay 20% tax on that every year and capital gains of 15/20% in retirement when I sell some day... or adding $7,000.00 to my non-deductible traditional IRA in the same 500 ETF and having to pay no taxes until I start withdrawing in retirement BUT having then to pay tax on all growth as if it were regular income (perhaps 32% in my situation)?

IF I don't need the money in my lifetime, my heirs will inherit with a stepped up basis if I put the money in the taxable account (does that mean they pay no taxes on money inherited from a taxable account?) ...while if they inherit the same amount as an inherited IRA, they will have to take it out within 10 years and will be taxed as income on all growth.

Am I missing something? I always thought making even non-deductible contributions to my traditional IRA was a no-brainer but now I am not so sure!
livesoft
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Re: Why should I contribute to my non-deductible IRA?

Post by livesoft »

I would only make a non-deductible tIRA contribution if that tIRA contribution could be converted to a Roth IRA in a reasonable (i.e. short) amount of time at all no additional tax cost.

Otherwise, put the money in a taxable account invested tax efficiently.

I did not see you mention Roth conversion. It can be a powerful method for those that understand it.
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Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

@livesoft, thank you for pointing out that I might convert that traditional IRA contribution to a ROTH IRA someday. That is a possible advantage though I am not sure that in my current federal marginal tax rate of 35% and high tax state that I would want to do so. But are you saying that I might open a new traditional IRA, make a contribution with after tax money and then immediately convert it to a Roth IRA without having to pay taxes on the conversion?
GreendaleCC
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Re: Why should I contribute to my non-deductible IRA?

Post by GreendaleCC »

Please read this to understand the important caveats:

https://www.bogleheads.org/wiki/Backdoor_Roth
tashnewbie
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Re: Why should I contribute to my non-deductible IRA?

Post by tashnewbie »

See: Backdoor Roth

If you don’t have any pretax IRAs (Traditional, Rollover, SEP, SIMPLE), then you can easily do backdoor Roth IRA contributions. You should prefer that over taxable investing because you’re using after-tax funds in both situations.

You wouldn’t owe any taxes on the basis ($7k) you convert using the backdoor method. You’d have to pay taxes on any gains before the conversion but those should be nonexistent or negligible if you don’t invest the money while in the TIRA or do the conversion quickly after making the TIRA contribution.

If you have pretax IRAs, then just put the money in a taxable account instead of using the backdoor method.
rkhusky
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Re: Why should I contribute to my non-deductible IRA?

Post by rkhusky »

Holding bonds or other tax inefficient investments in a non-deductible tIRA is fine.
But a tax efficient stock fund is better in a taxable account.

See: https://www.bogleheads.org/wiki/Non-ded ... tional_IRA
Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

Sorry, I really should have followed the format for making new posts. I do already have $260,000 in a traditional IRA which I think nixes the idea of doing an immediate backdoor Roth conversion of a new $7,000.00 traditional IRA for 2021. I read the article kindly linked by @GreendaleCC, where I learned that all my traditional IRAs from any all brokerages are looked at when calculating taxes on the backdoor ROTH IRA. I think that means the majority of the conversion (even if I just converted the $7,000.00 would be taxed as income. :? It was a nice thought but I don't think I can use that backdoor effectively.

So per @technewbie and @livesoft, I may simply be better off not making 2021 tIRA contributions... simply put them in my after tax account in a tax efficient stock fund/ETF per @rkhusky? This is very contrary to all I read in the past. But it is seeming to make sense to me. I have to convince my wife that something we have been doing religiously every year should now be abandoned to keep investments in our brokerage account! Any advice?
mhalley
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Re: Why should I contribute to my non-deductible IRA?

Post by mhalley »

I think explaining to the wife that tax laws have changed so your savings must change with it. The death of the stretch ira plus the increase in your income making Roth contributions impossible makes putting money in taxable accounts more advantageous to your heirs. You could look into rolling the trad ira over to a 401k to open up the backdoor. In addition, if your wife has no trad ira, then she could still do the backdoor Roth for her retirement saving. That way it’s not all or nothing.
Last edited by mhalley on Thu Dec 24, 2020 12:26 pm, edited 1 time in total.
LuckyGuy
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Re: Why should I contribute to my non-deductible IRA?

Post by LuckyGuy »

Do you have a 401k that you can move the traditional (pretax) money into? You could then rollover the rest into a Roth.
2tall4economy
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Re: Why should I contribute to my non-deductible IRA?

Post by 2tall4economy »

As others have highlighted, this is the specific example that a backdoor Roth was invented to handle.
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Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

Thanks for the additional responses! @mhalley, good idea but my wife also has an appreciated tIRA so having her do the backdoor IRA will not work for 2021 for either of us. But some of you seem to be suggesting that if my employer allows me to roll my appreciated tIRA out of Vanguard/Fidelity and INTO my existing workplace 401k, then I would no longer have a tIRA and could therefore do a backdoor Roth for 2021 and future years. Do I have that correct? If so, I would have to check workplace 401k fees which are with Fidelity so they should not be too high. Also, I would have to think about how I could track my basis from tIRA after mixing it with a workplace 401k.
Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

@luckyguy, don't we all fund our 401ks with pretax money? That we can do. But the only place I see information about using a 401k to do a mega back door Roth IRA has to do with employers that allow post-tax contributions to 401ks with in-service conversions allowed. That we don't have access to. So does that mean we cannot use the 401k to convert to a Roth?
retiredjg
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Re: Why should I contribute to my non-deductible IRA?

Post by retiredjg »

Sam-I-Am-Not wrote: Thu Dec 24, 2020 11:54 am I have to convince my wife that something we have been doing religiously every year should now be abandoned to keep investments in our brokerage account!
You mention making what appear to be non-deductible contributions to tIRA year after year. Have these contributions been documented on Form 8606 (one for you and one for your wife) each year?

If not, you will need to do that or you will pay tax on that money a second time when you start taking money out of IRA.

Also, you cannot roll any of those non-deductible contributions into your 401k so don't even think of doing that until you get the non-deductible contributions documented. Your 401k plan cannot accept any after-tax money.
Makefile
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Re: Why should I contribute to my non-deductible IRA?

Post by Makefile »

Sam-I-Am-Not wrote: Thu Dec 24, 2020 1:55 pm Thanks for the additional responses! @mhalley, good idea but my wife also has an appreciated tIRA so having her do the backdoor IRA will not work for 2021 for either of us. But some of you seem to be suggesting that if my employer allows me to roll my appreciated tIRA out of Vanguard/Fidelity and INTO my existing workplace 401k, then I would no longer have a tIRA and could therefore do a backdoor Roth for 2021 and future years. Do I have that correct? If so, I would have to check workplace 401k fees which are with Fidelity so they should not be too high. Also, I would have to think about how I could track my basis from tIRA after mixing it with a workplace 401k.
Yes! The 401(k) has to allow "rollovers from a traditional IRA" but not require that the IRA be a "rollover IRA".
As you mention, you can only roll over the pre-tax portion from the IRA to the 401(k). You have to leave the basis in the IRA. This is a trick because the tax law says when you do a normal withdrawal from a traditional IRA, it's considered a mixture of basis and deductible contributions+earnings, while when you rollover, you're allowed to treat the rollover as only deductible contributions+earnings, leaving the basis behind.

So, in your situation you'd have to be super careful to roll over only the non-basis portion. The form will make you certify that there is no basis in the rollover. I don't know what happens if you do a rollover and then there is a market decline causing your remaining balance to drop below the basis.
Makefile
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Re: Why should I contribute to my non-deductible IRA?

Post by Makefile »

Sam-I-Am-Not wrote: Thu Dec 24, 2020 11:54 am So per @technewbie and @livesoft, I may simply be better off not making 2021 tIRA contributions... simply put them in my after tax account in a tax efficient stock fund/ETF per @rkhusky? This is very contrary to all I read in the past. But it is seeming to make sense to me. I have to convince my wife that something we have been doing religiously every year should now be abandoned to keep investments in our brokerage account! Any advice?
Non-deductible traditional IRA contributions made more sense if you time travel to back before Roth IRAs existed (1997). In addition to not having a Roth available, interest rates were higher, stock dividend yield was higher, inflation was higher, and dividends were taxed as ordinary income--all those things combining to make the tax deferral of the annual income generated by your investments more valuable, and the conversion of capital gains to regular income less of a disadvantage.
Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

@retiredjg, yes we file 8606, so we have our tIRA basis tracked. @Makefile, you are correct in that a lot of my investing knowledge was had in the '90s and things sure have changed! But, if I understand you, if our 401k allows rollovers from a tIRA (not merely a preexisting rollover IRA) then I can rollover everything other than the basis out of the tIRA, leaving just the basis behind. Then I could do to a recharacterization of the tIRA (now just my basis) into a Roth IRA? That way I won't owe an appreciable tax at all? This is brilliant if true...and if I can conduct the whole thing correctly! :happy Each year, including 2021, I could therefore create a new 7000k tIRA and shortly thereafter recharacterize it as a Roth IRA? Wow!
retiredjg
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Re: Why should I contribute to my non-deductible IRA?

Post by retiredjg »

Sam-I-Am-Not wrote: Thu Dec 24, 2020 4:13 pm ...if our 401k allows rollovers from a tIRA (not merely a preexisting rollover IRA) then I can rollover everything other than the basis out of the tIRA, leaving just the basis behind.
Yes. It is helpful to liquidate first. You must leave at least as much as the basis behind and you don't want things changing value as you are doing the rollover.

Then I could do to a recharacterization of the tIRA (now just my basis) into a Roth IRA?
You would convert it to Roth.

That way I won't owe an appreciable tax at all?
If you leave behind only the basis and if it does not grow before you convert it to Roth, you will owe no tax on it at all.

This is brilliant if true...and if I can conduct the whole thing correctly! :happy Each year, including 2021, I could therefore create a new 7000k tIRA and shortly thereafter recharacterize it as a Roth IRA? Wow!
Yes, but don't get too excited yet. This is easy to do and tricky to document on your taxes. Get very familiar with that (it involves Form 8606) before doing all this. There is information in the Wiki and follow the links on the Wiki page as well.
cas
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Re: Why should I contribute to my non-deductible IRA?

Post by cas »

Sam-I-Am-Not wrote: Thu Dec 24, 2020 4:13 pm I could therefore create a new 7000k tIRA and shortly thereafter recharacterize it as a Roth IRA? Wow!
Not quite. Should be
I could therefore create a new 7000k tIRA and shortly thereafter recharacterize convert it as to a Roth IRA? Wow!
Or being picky, maybe even
I could therefore create a new contribute a 7000k non-deductible contribution to my empty tIRA and shortly thereafter recharacterize convert it as to a Roth IRA? Wow!
There are waaay too many words that start with "c" (or have prominent "c" sounds in them) involved with IRAs. Contribute. Convert. Recharacterize. Very Unpleasant Things can result if you use the wrong "c" word when speaking with a customer service rep or doing transactions on the website.
wrongfunds
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Re: Why should I contribute to my non-deductible IRA?

Post by wrongfunds »

Every year I think about doing this but then always chicken out for following reasons

1) Even though both sides (aka 401K and R/O IRA) assets are with Fidelity, the only way they will do the conversion is to cut the paper check made out to me and then I will have to sign it back to my 401K and then US mail it to them. That will keep the money un-invested for at least few weeks.
2) Even though in theory, this will be non-taxable transaction, I do not know how Fidelity will code the 1099R and if TurboTax would be happy with it

With multiple hundred thousands of dollars at stake, I am avoiding the above risk.
Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

@cas, thank you for the correction to my chosen word as I used the wrong one which can be very confusing. @retiredjb, thank you for confirming my understanding that I may be able to convert the basis (proved by my 8606) in my tIRA by first rolling over everything except the basis from my tIRA to an employer sponsored 401k...and then converting the remaining basis to a Roth IRA thereby avoiding immediate tax and penalties. @wrongfunds, thank you for worrying me about the whole thing! :shock: Employer's 401k, like your's, is with Fidelity! From what you state, Fidelity will allow me go through these steps BUT will insists on issuing me a paper check to me which I will have to sign back and place in the US mail to them. The reason @wrongfunds has made me nervous about these steps is that I will be receiving a check to sign over back to my 401k plan. I guess you have not done this, @wrongfunds, because you are afraid the IRS may somehow treat your receipt of the check as a disbursement which could lead to taxes and penalties that would ruin the whole point of the exercise? Is that correct? That idea scares me too! When did you last check with Fidelity about this process? Maybe it has changed/improved since then? Instead of mailing the signed check, could I just drop it off at my local Fidelity office?
freight_train
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Re: Why should I contribute to my non-deductible IRA?

Post by freight_train »

wrongfunds wrote: Thu Dec 24, 2020 5:06 pm Every year I think about doing this but then always chicken out for following reasons

1) Even though both sides (aka 401K and R/O IRA) assets are with Fidelity, the only way they will do the conversion is to cut the paper check made out to me and then I will have to sign it back to my 401K and then US mail it to them.
I rolled into a Fidelity 401k and they have a mobile app that allows you to send them an image of the check. That saved several days and some risk of loss in the mail.
retiredjg
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Re: Why should I contribute to my non-deductible IRA?

Post by retiredjg »

Be careful about signing the check - it may be made out to your 401k plan, not to you.

People do this all the time. I think you are more worried than you need to be.
Topic Author
Sam-I-Am-Not
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Re: Why should I contribute to my non-deductible IRA?

Post by Sam-I-Am-Not »

OK, thanks@!
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celia
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Re: Why should I contribute to my non-deductible IRA?

Post by celia »

Sam-I-Am-Not wrote: Thu Dec 24, 2020 1:55 pm @mhalley, good idea but my wife also has an appreciated tIRA so having her do the backdoor IRA will not work for 2021 for either of us.
Your tIRA and her tIRA have nothing to do with each other. However, if your joint income is too high to contribute directly to a Roth, then it is also too high for the other person. As long as your tIRA is emptied before April 15, 2021, you will also be able to make a non-deductible contribution for 2020, then convert it a day later.
But some of you seem to be suggesting that if my employer allows me to roll my appreciated tIRA out of Vanguard/Fidelity and INTO my existing workplace 401k, then I would no longer have a tIRA and could therefore do a backdoor Roth for 2021 and future years. Do I have that correct?
Yes, but you would still have a tIRA, but it would be empty. You can re-use the same tIRA for the non-deductible contribution each year before doing the Roth conversion.
Also, I would have to think about how I could track my basis from tIRA after mixing it with a workplace 401k.
You are not allowed to rollover any basis from a tIRA to a 401K. 401Ks ARE NOT permitted to accept that. Do you already have post-tax money in the tIRA? Those dollars would have to stay behind in the tIRA. After the 401K rollover is complete, then you can convert the post-tax money tax-free.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
placeholder
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Re: Why should I contribute to my non-deductible IRA?

Post by placeholder »

You want a direct rollover so the check is made out to the receiving custodian (they should give you instructions on how the check should be made out) then all you do is forward it on to the 401k which is something I have done in the past without problem.
TheDogFather
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Re: Why should I contribute to my non-deductible IRA?

Post by TheDogFather »

This has been very informative. My wife can contribute a small amount (<$10k) to a non-deductible IRA and we were going using that for a bond fund VBTLX to help get our allocation closer to our target. Our tax-deductible accounts are all bonds already and so the alternative would be bonds in our taxable brokerage account.

Our marginal rate is 32% (but lower next year), but wondering given the small amounts involved and the additional burden, whether the taxable brokerage account is just a better and simpler choice?
Silverado
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Re: Why should I contribute to my non-deductible IRA?

Post by Silverado »

TheDogFather wrote: Mon Dec 28, 2020 12:03 pm This has been very informative. My wife can contribute a small amount (<$10k) to a non-deductible IRA and we were going using that for a bond fund VBTLX to help get our allocation closer to our target. Our tax-deductible accounts are all bonds already and so the alternative would be bonds in our taxable brokerage account.

Our marginal rate is 32% (but lower next year), but wondering given the small amounts involved and the additional burden, whether the taxable brokerage account is just a better and simpler choice?
You may want to start a new thread and expand on your situation. Need to know if you have other IRA dollars.
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