Are non-deductible Trad IRAs ever worth it?

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NYCaviator
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Are non-deductible Trad IRAs ever worth it?

Post by NYCaviator »

We typically fund our backdoor Roth at the beginning of each January, but will be waiting this coming year to see what happens with pending legislation. Without getting into that, for someone who is over the income limits for both deductible IRA or Roth IRA, does making non-deductible traditional IRA contributions ever make sense, or should I just put that money in our taxable account?

Having maxed our our 401ks, we'd love to find some other tax sheltered/"asset protected" places to put retirement savings, but don't have many other options.
livesoft
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Re: Are non-deductible Trad IRAs ever worth it?

Post by livesoft »

We had very old non-deductible tIRAs contributions when converting them to a Roth was not an option. They were NOT worth it.

Of course, non-deductible tIRA contributions are worth it if they get converted in a reasonable time to a Roth IRA. Otherwise NO. That's because it is very trivial to invest tax-efficiently in a taxable account instead where gains would taxed at a prefer rate, gains can be offset by losses, and tax-loss harvesting is possible. In contrast, gains from a non-deductible tIRA contribution are taxed as ordinary income. It is true that if you lose principal in a non-deductible tIRA contribution, then any gains will "top up" that lost principal before they are taxed.

I suppose if you are not going to get any gains nor losses, then no harm, no foul to make non-deductible tIRA contributions. Except for the withdrawal penalties before age 59.5.

So why not use a joint taxable account invested tax-efficiently? Taxes could even be negative on such an account. If you live in NYC, then a triple-tax free NY tax-exempt muni bond fund would be something to look into.
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retiredjg
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Re: Are non-deductible Trad IRAs ever worth it?

Post by retiredjg »

In general, a non-deductible contribution to tIRA does not make sense to me...unless it is the first step to a backdoor process. I'd rather put the money into a taxable account.

There is an exception - for a person who wants more tax-deferred space to hold bonds, an IRA is a perfect way to get more bond space and it does not matter if the contributions were deductible or not. Of course, this only works if you will not be using the backdoor process.

However, if tax law is the same in January as now, I think I'd just do the backdoor anyway since the Roth conversion step cannot be undone.
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NYCaviator
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Re: Are non-deductible Trad IRAs ever worth it?

Post by NYCaviator »

retiredjg wrote: Wed Dec 01, 2021 7:07 am However, if tax law is the same in January as now, I think I'd just do the backdoor anyway since the Roth conversion step cannot be undone.
This is my concern. Is there a penalty if I do a Backdoor Roth on Jan 15 and then later the tax law changes for 2022? I don't want to do something that can't be undone and that is somehow penalized tax wise.

I am trying to tread lightly by not discussing pending legislation, but I think it makes sense to know what the options are since January is quickly creeping up on us.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by NYCaviator »

livesoft wrote: Wed Dec 01, 2021 7:02 am We had very old non-deductible tIRAs contributions when converting them to a Roth was not an option. They were NOT worth it.

Of course, non-deductible tIRA contributions are worth it if they get converted in a reasonable time to a Roth IRA. Otherwise NO. That's because it is very trivial to invest tax-efficiently in a taxable account instead where gains would taxed at a prefer rate, gains can be offset by losses, and tax-loss harvesting is possible. In contrast, gains from a non-deductible tIRA contribution are taxed as ordinary income. It is true that if you lose principal in a non-deductible tIRA contribution, then any gains will "top up" that lost principal before they are taxed.

I suppose if you are not going to get any gains nor losses, then no harm, no foul to make non-deductible tIRA contributions. Except for the withdrawal penalties before age 59.5.

So why not use a joint taxable account invested tax-efficiently? Taxes could even be negative on such an account. If you live in NYC, then a triple-tax free NY tax-exempt muni bond fund would be something to look into.
This makes a lot of sense, and is what I was thinking. We don't hold any bonds in taxable or Roth at this point. I keep those in the 401ks. We can just stay on the same path and pour that money into the taxable.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by fortunefavored »

retiredjg wrote: Wed Dec 01, 2021 7:07 am There is an exception - for a person who wants more tax-deferred space to hold bonds, an IRA is a perfect way to get more bond space and it does not matter if the contributions were deductible or not. Of course, this only works if you will not be using the backdoor process.
That was always my reasoning for doing it - my taxable savings dwarfed my IRA/401k space (and indeed I still need a big chunk of fixed income in taxable.) Right before early retirement I was able to clean my own mixed IRAs by rolling over all my old IRAs into a 401k and then backdooring my basis to Roth.

Is it worth the hassle? I dunno.. as I get older I want things to be as simple as possible, so it annoys me to have to keep tracking a basis.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by retiredjg »

NYCaviator wrote: Wed Dec 01, 2021 7:14 am This is my concern. Is there a penalty if I do a Backdoor Roth on Jan 15 and then later the tax law changes for 2022? I don't want to do something that can't be undone and that is somehow penalized tax wise.
How can there be a penalty for doing something that is not prohibited when you do it?

This is simply my opinion and what I would consider a reasonable choice. Your opinion may be different, in which case perhaps you should wait.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by exodusNH »

NYCaviator wrote: Wed Dec 01, 2021 6:43 am We typically fund our backdoor Roth at the beginning of each January, but will be waiting this coming year to see what happens with pending legislation. Without getting into that, for someone who is over the income limits for both deductible IRA or Roth IRA, does making non-deductible traditional IRA contributions ever make sense, or should I just put that money in our taxable account?

Having maxed our our 401ks, we'd love to find some other tax sheltered/"asset protected" places to put retirement savings, but don't have many other options.
I Bonds give you a small amount of additional space, $10K per person per year. If you need bonds, they're a great inflation-protected option. If you have 20 years, EE Bonds give you another $10K as well. Those double at exactly 20 years, but are only worth it if you hold them for exactly that long since the actual rate is 0.10%.

Non-deductible traditional IRAs would give you some space to hold more bonds, whether bond funds or individual ones you purchase and hold. (E.g. TIPS due to the phantom income.)

If $6000 each won't move the needle much, they probably don't make a lot of sense. As you noted, it turns capital gains into ordinary income, and will eventually be subject to RMDs. But perhaps if you have a period of time between retirement and taking Social Security, your income rate will be lower.

On the other hand, IRAs, depending on state, have greater protections from creditors. They may also not be counted as assets for financial aid.
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riverant
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Re: Are non-deductible Trad IRAs ever worth it?

Post by riverant »

NYCaviator wrote: Wed Dec 01, 2021 7:14 am
retiredjg wrote: Wed Dec 01, 2021 7:07 am However, if tax law is the same in January as now, I think I'd just do the backdoor anyway since the Roth conversion step cannot be undone.
This is my concern. Is there a penalty if I do a Backdoor Roth on Jan 15 and then later the tax law changes for 2022? I don't want to do something that can't be undone and that is somehow penalized tax wise.

I am trying to tread lightly by not discussing pending legislation, but I think it makes sense to know what the options are since January is quickly creeping up on us.
I think it’s a good question… I’m not sure why discussing action to hedge against pending legislation would not be allowed. Seems a bit rigid if so…

In any event, I think it would be unwise to do a backdoor Roth on Jan 15 if the current legislation is still up on the air. Making things retroactive to Jan 1 is not without precedent.
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Harry Livermore
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Re: Are non-deductible Trad IRAs ever worth it?

Post by Harry Livermore »

I funded ND IRAs in the distant past, as I was over the income limit for deductibility and the Roth did not exist. My logic as a young man was to get the tax-deferred growth and hope that tax rates in the future were lower or remained similar. At the time, most of my investing was in managed mutual funds, most of which threw off capital gains etc. every year, so it made sense to me at the time to shelter that income from my current tax bill.
We have long since converted those to Roths.
I'm not sure it makes sense as current tax law stands, and plus, as others have said, there are some compelling choices for low- or no- tax investments in the "taxable" space (VTSAX is very efficient) Capital gains when you are an early retiree/semi-retired (and may have low income) can be 0%, so some taxable investing might actually result in a lower tax bill than RMDs from your IRAs or 401(k) type plans. And, of course, there is no RMD for your taxable investments, so having money there gives you some flexibility.
I'm sure, since everyone's situation is different, an argument can be made for specific cases that it is still a good strategy.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by Silverado »

I thought they would be worth it at the time, 2008-2015, when I recommended we do it every year. Hindsight tells me that was not an optimal choice (though much better than simply spending the money) We have large rollover IRA balances also, so it will be fun unwinding everything in those early retirement years.

All the non deductible dollars are in CDs, earning the low returns you expect right now.

We are fortunate to be able to offset these types of suboptimal acts by plowing large amounts into our taxable account (all VTSAX) every month. Having the charity that gets 100% of our estate get a few thousand less is something I can tolerate.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by mr_brightside »

there is probably some value in the 'lock-box effect' you get with it being a retirement account and the associated 10% penalty for early withdrawal during your accumulation phase

my bet is there is - for most people - a tendency to dip into the accounts that are not specifically 'for retirement'

for college, weddings, vacations, home improvement, etc... ymmv of course

there are also i believe some legal protections for retirement accounts vs regular accounts. also iirc FAFSA treats 'retirement' money different from 'savings' if that matters...

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Re: Are non-deductible Trad IRAs ever worth it?

Post by langelgjm »

I normally do our backdoor Roth contributions in early January, so I'm keeping an eye on the news. If nothing has changed by January 3, I'm not sure what I'll do, but I'm leaning towards just carrying on as usual.

Not sure how anyone can be faulted for doing the backdoor Roth under current law. And current law also doesn't allow you to undo a Roth conversion, either, so once it's done, it's done. Retroactively saying you can't do it seems like the very definition of an ex post facto law.

If things have changed before the new year, then I'll probably just increase contributions to our taxable account by the amount that would have gone to IRAs. Not much point in making a traditional IRA contribution when there's no deduction available, capital gains taxes are lower, and taxable accounts don't have restrictions on distributions.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by tibbitts »

TJat wrote: Wed Dec 01, 2021 8:09 am In any event, I think it would be unwise to do a backdoor Roth on Jan 15 if the current legislation is still up on the air. Making things retroactive to Jan 1 is not without precedent.
I know that things like rates might have changed retroactively (although I only remember cases with newer rates being more favorable), but does anyone know of cases where an activity was made retroactively illegal (related to taxes or not?)
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Re: Are non-deductible Trad IRAs ever worth it?

Post by billthecat »

fortunefavored wrote: Wed Dec 01, 2021 7:23 am
retiredjg wrote: Wed Dec 01, 2021 7:07 am There is an exception - for a person who wants more tax-deferred space to hold bonds, an IRA is a perfect way to get more bond space and it does not matter if the contributions were deductible or not. Of course, this only works if you will not be using the backdoor process.
That was always my reasoning for doing it - my taxable savings dwarfed my IRA/401k space (and indeed I still need a big chunk of fixed income in taxable.) Right before early retirement I was able to clean my own mixed IRAs by rolling over all my old IRAs into a 401k and then backdooring my basis to Roth.

Is it worth the hassle? I dunno.. as I get older I want things to be as simple as possible, so it annoys me to have to keep tracking a basis.
That's my situation as well - taxable is 85% of my total net worth. So I figured I would still do non-deductible contributions to my traditional IRA (currently zero balance, of course), and invest in total bond. And in my 401K, make after tax contributions, and invest in either stable value or total bond. The premise, of course, is that I have equity investments in my taxable account (and Roth) to counter-balance and achieve my desired overall asset allocation.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by tibbitts »

Silverado wrote: Wed Dec 01, 2021 9:33 am I thought they would be worth it at the time, 2008-2015, when I recommended we do it every year.
I did too, although it only applied to me for a couple of years. It was a terrible decision of course, and now I have the lifetime 8606 curse to remind me.
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Re: Are non-deductible Trad IRAs ever worth it?

Post by billthecat »

tibbitts wrote: Wed Dec 01, 2021 11:46 am
Silverado wrote: Wed Dec 01, 2021 9:33 am I thought they would be worth it at the time, 2008-2015, when I recommended we do it every year.
I did too, although it only applied to me for a couple of years. It was a terrible decision of course, and now I have the lifetime 8606 curse to remind me.
Could a person make non-deductible contributions to a traditional IRA, and then roll them over into a traditional 401K, obviating the need for 8606's?
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Re: Are non-deductible Trad IRAs ever worth it?

Post by tibbitts »

billthecat wrote: Thu Dec 02, 2021 12:16 pm
tibbitts wrote: Wed Dec 01, 2021 11:46 am
Silverado wrote: Wed Dec 01, 2021 9:33 am I thought they would be worth it at the time, 2008-2015, when I recommended we do it every year.
I did too, although it only applied to me for a couple of years. It was a terrible decision of course, and now I have the lifetime 8606 curse to remind me.
Could a person make non-deductible contributions to a traditional IRA, and then roll them over into a traditional 401K, obviating the need for 8606's?
If you are willing to roll your entire deductible balance to an employer plan that accepts them, then yes, you can eliminate the 8606. Many employer plans don't accept such contributions; some do. There can be logistical out-of-market issues with the typical USmail paper process that are challenging and/or costly to hedge for (or you can do multiple smaller moves - extended torture.) In my case non-deductible contributions are less than 1% of my IRA balance.
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FiveK
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Re: Are non-deductible Trad IRAs ever worth it?

Post by FiveK »

The Non-deductible traditional IRA - Bogleheads wiki article has some analysis.
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