401k vs. IRA when AGI is near the IRA phase-out

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28fe6
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Joined: Wed Jan 03, 2018 9:01 am

401k vs. IRA when AGI is near the IRA phase-out

Post by 28fe6 »

I would like to contribute to tax-deferred retirement savings, but my AGI is above the $105,000 phase-out range for deductibility of tIRA contributions.

If I am above the phase-out range for deductibility of tIRA contributions, then any money I contribute to a tIRA will not be deductible. Question 1, if I contribute that money to my IRA anyway, and do not deduct it, then when I withdraw the money in retirement, can the original (non-deductible) contribution and/or any earnings be withdrawn tax-free (since I already paid taxes on it when I contributed). I am trying to understand the tax treatment differences between a non-deductible IRA contribution and a taxable investment, to see if there is any advantage to making a non-deductible contribution to my IRA, rather than simply contribute that amount to my taxable account instead.

Question 2, my 401k is not max'd. Therefore, if I contribute the money to my 401k instead of IRA, not only would I be able to deduct the contribution from my taxable income, it could potentially lower my AGI into the tIRA phase-out range, since 401k is an above-the-line deduction. Therefore, by contributing to my 401k, not only do I deduct the full amount of the 401k contribution (up to the yearly limit for 401k contributions), I also potentially re-open my IRA deductibility my lowering my AGI. Is this correct?

If true, it means that I should not contribute to a tIRA at all unless I've already maxed my 401k, because contributing to the 401k has the same immediate tax benefit (deductibility) as an IRA, plus contributions to 401k lower your AGI which can help with other credits and phase-outs. Am I understanding right? Previously, I considered IRA and 401k contributions equivalant, but if 401k also lowers your AGI, then 401k seems better.
retiredjg
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Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by retiredjg »

28fe6 wrote: Mon Sep 13, 2021 10:47 am Question 1, if I contribute that money to my IRA anyway, and do not deduct it, then when I withdraw the money in retirement, can the original (non-deductible) contribution and/or any earnings be withdrawn tax-free (since I already paid taxes on it when I contributed).
Yes. If you go this route, you document the non-deductible contributions on Form 8606 on your taxes. When withdrawing, use the same form to determine how much of your withdrawal is taxable after getting "credit" for some of that money having been taxed already.

I am trying to understand the tax treatment differences between a non-deductible IRA contribution and a taxable investment, to see if there is any advantage to making a non-deductible contribution to my IRA, rather than simply contribute that amount to my taxable account instead.
There is usually not a good reason to use non-deductible contributions instead of putting the money in taxable. There are a few exceptions - such as needing more space for bonds in your portfolio.

Question 2, my 401k is not max'd. Therefore, if I contribute the money to my 401k instead of IRA, not only would I be able to deduct the contribution from my taxable income, it could potentially lower my AGI into the tIRA phase-out range, since 401k is an above-the-line deduction. Therefore, by contributing to my 401k, not only do I deduct the full amount of the 401k contribution (up to the yearly limit for 401k contributions), I also potentially re-open my IRA deductibility my lowering my AGI. Is this correct?
Yes, this is correct.

If true, it means that I should not contribute to a tIRA at all unless I've already maxed my 401k, because contributing to the 401k has the same immediate tax benefit (deductibility) as an IRA, plus contributions to 401k lower your AGI which can help with other credits and phase-outs. Am I understanding right? Previously, I considered IRA and 401k contributions equivalant, but if 401k also lowers your AGI, then 401k seems better.
Correct. Also consider if traditional 401k combined with Roth IRA is a good choice for you (If you are able to save that much).
epargnant
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Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by epargnant »

28fe6 wrote: Mon Sep 13, 2021 10:47 am I would like to contribute to tax-deferred retirement savings, but my AGI is above the $105,000 phase-out range for deductibility of tIRA contributions.

If I am above the phase-out range for deductibility of tIRA contributions, then any money I contribute to a tIRA will not be deductible. Question 1, if I contribute that money to my IRA anyway, and do not deduct it, then when I withdraw the money in retirement, can the original (non-deductible) contribution and/or any earnings be withdrawn tax-free (since I already paid taxes on it when I contributed). I am trying to understand the tax treatment differences between a non-deductible IRA contribution and a taxable investment, to see if there is any advantage to making a non-deductible contribution to my IRA, rather than simply contribute that amount to my taxable account instead.

Question 2, my 401k is not max'd. Therefore, if I contribute the money to my 401k instead of IRA, not only would I be able to deduct the contribution from my taxable income, it could potentially lower my AGI into the tIRA phase-out range, since 401k is an above-the-line deduction. Therefore, by contributing to my 401k, not only do I deduct the full amount of the 401k contribution (up to the yearly limit for 401k contributions), I also potentially re-open my IRA deductibility my lowering my AGI. Is this correct?

If true, it means that I should not contribute to a tIRA at all unless I've already maxed my 401k, because contributing to the 401k has the same immediate tax benefit (deductibility) as an IRA, plus contributions to 401k lower your AGI which can help with other credits and phase-outs. Am I understanding right? Previously, I considered IRA and 401k contributions equivalant, but if 401k also lowers your AGI, then 401k seems better.
Question 1: You are correct, you would not have to pay taxes on the contribution amount again. You track your "basis" in non-deductible IRA contributions on IRS form 8606 each year. https://www.irs.gov/forms-pubs/about-form-8606. However, there is generally not much advantage to that. None in your case that I can see. Your options are 401K vs Roth IRA.

Question 2: Your conclusions are correct. Absolutely no point in contributing to a tIRA if you have not maxed out your 401K. And yes, contributing to a 401K lowers your AGI which helps with phase-outs. Once you hit your 401K max contribution, consider a Roth. Not sure many Bogleheads would advocate putting money in a taxable account unless you're maxing both of those. I suppose if you have horrible 401K investment options, they would say to contribute to get the 401K match, then Roth, then taxable.

You are using married filling jointly numbers so I assume you're married. Your spouse can also contribute to a Roth or tIRA, even if not working. If he or she is working and/or does not have a 401K plan, he/she can deduct tIRA contributions if your combined income is under $198K.
secondcor521
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Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by secondcor521 »

28fe6 wrote: Mon Sep 13, 2021 10:47 am Previously, I considered IRA and 401k contributions equivalant, but if 401k also lowers your AGI, then 401k seems better.
They're not entirely equivalent, but they're more equivalent than you might think.

Traditional IRA contributions, if deductible, reduce AGI just like 401(k) contributions. In fact, the "A" in AGI is "Adjusted", and a deductible traditional IRA contribution is an adjustment - it's even listed on Schedule 1 in the "Adjustments to Income" section (line 19 on the 2020 Schedule 1). So such contributions will help with all AGI-related items just like 401(k) contributions do.

However, deductible traditional IRA contributions cannot be used to reduce one's AGI into or below the phase out ranges for such contributions - See instructions for Schedule 1 line 19. So in that sense what you wrote about using 401(k) contributions is more helpful because they can, unlike deductible traditional IRA contributions, get AGI down into the phase out range.
Topic Author
28fe6
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Joined: Wed Jan 03, 2018 9:01 am

Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by 28fe6 »

Thanks everyone for all the responses.

I will not contribute to my tIRA unless my 401k becomes maxed, since there's no benefit (my 401k has fine fund choices). I could have my wife contribute to her tIRA, but once again if my 401k is not maxed then it would be better for the household for me to put the money toward my 401k instead (leaving aside ownership or beneficiary issues of hers vs. mine).
Not sure many Bogleheads would advocate putting money in a taxable account unless you're maxing both of those [401k and Roth]
Taxable has liquidity advantage over Roth, in that I can sell and eat my taxable investments without the additional Roth-withdrawal penalty.

I can also tax-loss and tax-gain harvest my taxable investments. This is probably not enough of an advantage to outweigh the tax-free growth of Roth, but could help close the gap between taxable and Roth. For example, I usually donate appreciated securities in an amount which I would otherwise donate anyway, and re-invest. This raises my tax basis at some frequency and helps taxable be somewhat more "Roth-like".
AnEngineer
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Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by AnEngineer »

28fe6 wrote: Mon Sep 13, 2021 1:24 pm Taxable has liquidity advantage over Roth, in that I can sell and eat my taxable investments without the additional Roth-withdrawal penalty.
You can always withdraw Roth contributions without any penalty.
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FiveK
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Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by FiveK »

28fe6 wrote: Mon Sep 13, 2021 10:47 am If true, it means that I should not contribute to a tIRA at all unless I've already maxed my 401k, because contributing to the 401k has the same immediate tax benefit (deductibility) as an IRA, plus contributions to 401k lower your AGI which can help with other credits and phase-outs. Am I understanding right?
Yes. Your situation is exactly what the Choosing between an employer retirement plan and an IRA section of that wiki had in mind when saying
If you prefer traditional to Roth, and traditional contributions to the employer's plan are needed to reduce your Modified Adjusted Gross Income (MAGI) for traditional IRA purposes enough to allow a full or partial IRA deduction (see IRA Deduction Limits), consider swapping steps 5 and 6.
exodusNH
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Re: 401k vs. IRA when AGI is near the IRA phase-out

Post by exodusNH »

28fe6 wrote: Mon Sep 13, 2021 1:24 pm Thanks everyone for all the responses.

I will not contribute to my tIRA unless my 401k becomes maxed, since there's no benefit (my 401k has fine fund choices). I could have my wife contribute to her tIRA, but once again if my 401k is not maxed then it would be better for the household for me to put the money toward my 401k instead (leaving aside ownership or beneficiary issues of hers vs. mine).
Not sure many Bogleheads would advocate putting money in a taxable account unless you're maxing both of those [401k and Roth]
Taxable has liquidity advantage over Roth, in that I can sell and eat my taxable investments without the additional Roth-withdrawal penalty.

I can also tax-loss and tax-gain harvest my taxable investments. This is probably not enough of an advantage to outweigh the tax-free growth of Roth, but could help close the gap between taxable and Roth. For example, I usually donate appreciated securities in an amount which I would otherwise donate anyway, and re-invest. This raises my tax basis at some frequency and helps taxable be somewhat more "Roth-like".
You can always pull your contributions from your Roth, just not the gains. Not that you want to do that, though, because you can't refill the Roth. (Excepting maybe doing so within 60 days if you haven't done another within 12 months.)

If you think you might need the money, taxable is the way to go. Just keep in mind that money you might need should only be invested in instruments that match the timeline of the need. If that need is less than 2 years, it should be in a FDIC-insured account, not the market.
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