Any advantage to IRA if I can't deduct contributions?

April 25, 2013 3:09 PM

I'm taking a new job with a very small company that doesn't offer a 401k. My spouse's job does offer a 401k. Based on what I see on this page, with our income, we would not be able to deduct any contributions I make to an IRA, and we're not eligible for a Roth IRA. So what is my best retirement investment strategy?

Is there any substantial benefit to using an IRA rather than just a regular brokerage account? We'd like to save more than we can by maxing out my spouse's 401k, so just adding it in there doesn't really solve the problem. If I understand what I've read correctly, I wouldn't have to pay capital gains on any sales within an IRA. But it also comes with serious limitations, like additional taxes if I withdraw before age 59 1/2. So I'm not sure if there's a net gain. What else should I consider?

posted by primethyme to Work & Money (8 answers total)

Best answer: You can make a backdoor Roth contribution.
posted by Arbac at 3:12 PM on April 25, 2013 [2 favorites]

You could try a backdoor Roth... Basically, the income limit for the Roth was poorly implemented, such that it doesn't really exist. You just need to create a regular IRA (which you can, even though the contributions won't be tax deductible). Then you can convert to a Roth.
posted by mr_roboto at 3:13 PM on April 25, 2013 [1 favorite]

In addition, IRAs shelter assets from creditors (in bankruptcy and also under many states' laws) and from financial aid consideration.
posted by payoto at 3:21 PM on April 25, 2013

Keep the back door in mind for the future. For the present, the most important feature of an IRA is not the deductibility of the contribution, but the tax-free growth over the next several decades, assuming as I do that you are perhaps in your 30s.

Consultation with a financial advisor is always a good idea, but if I were a 30-something DIYer, I would set up two accounts: one nondeductible IRA and one ordinary investment account. I would have them mirror each other as to investments. I would contribute $____ per month for the next decade, 50% to each. Then I would review them. Consider the back door then.

For the love of God, if you happen to have a deductible IRA, set up another nondeductible IRA for this purpose. Do not combine them.
posted by megatherium at 4:00 PM on April 25, 2013

I would set up two accounts: one nondeductible IRA and one ordinary investment account. I would have them mirror each other as to investments. I would contribute $____ per month for the next decade, 50% to each. Then I would review them. Consider the back door then.

Conversion is a taxable event, so you'd pay on the capital gains over that decade. This eliminates the advantage of tax-free growth. If you're going to convert, convert immediately. If you're not going to convert, why lock the money in an IRA when the contributions aren't deductible?
posted by mr_roboto at 4:35 PM on April 25, 2013

Yes, the advantage of the IRA is that you don't owe income taxes every year when the money (hopefully) grows. The tradeoff is that there are restrictions as to when you can get that money. A regular brokerage account requires you to pay tax on the gains, but the money is yours to do whatever you want with.
posted by gjc at 6:31 PM on April 25, 2013

Response by poster: You only have to pay tax when you realize the gains, though. It's not like I have to pay tax every year on all the shares of VTSMX (or whatever) I have just sitting in my taxable brokerage account. Regardless of tax status, I don't tend to trade a lot in my retirement accounts, so I don't think that's a huge issue.
posted by primethyme at 4:15 PM on April 26, 2013

It's not like I have to pay tax every year on all the shares of VTSMX (or whatever) I have just sitting in my taxable brokerage account.

Unless they pay dividends....
posted by mr_roboto at 4:37 PM on April 26, 2013