Ask Kim
When You Can't Deduct Retirement Savings
I don't qualify for a deductible IRA, so which would be a better alternative, a non-deductible IRA or a taxable account?
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
August 30, 2004
I don't qualify for a deductible IRA, so which would be a better alternative, a non-deductible IRA or a taxable account?
You're generally better with a taxable account. Now that long-term capital gains rates are so low, you're paying too big a price for the nondeductible IRA's tax deferral.
With a nondeductible IRA, you'll owe income taxes on your earnings when you withdraw the money, rather than long-term capital-gains taxes of just 15% (or less) if you invested in a taxable account.
With a taxable account, you also won't have to make required minimum distributions at age 70½ and your heirs won't owe income taxes on your earnings when you die.
Since you will be paying taxes on your dividends, capital-gains distributions and trades you make every year, though, it's essential to keep this money in tax-efficient investments. "If you want to have the best chance of having the highest after-tax return, the way to do it is to fund a taxable account using broad index funds or tax-managed mutual funds," says Francis Kinniry of Vanguard's Investment Counseling and Research Group, which offers many such funds.
But don't forget about another option: the Roth IRA. Even though you don't qualify for a deductible IRA you might be able to save in a Roth. You don't get to deduct your contributions, but you can withdraw your earnings tax-free after age 59½. And you can deduct your contributions at any time tax- and penalty-free.
The right to stash retirement cash in a Roth disappears as AGI rises between $150,000 and $160,000 on a joint return and between $95,000 and $110,000 on the return of a single person, whether filing as an individual, a head of household or a surviving spouse.
If your AGI on a joint return is $155,000, for example, that's halfway through the phaseout zone, so your maximum contribution would be cut in half: to $1,500.
When AGI passes the top of the phaseout zone, you may not contribute to a Roth at all. Note that the Roth phaseout zones apply regardless of whether you are covered by a retirement plan at work.
Married taxpayers who file separate returns may not contribute to Roth IRAs, regardless of their income.
