YOU ASK:

Is it worth investing in a non-deductible IRA?

WE ANSWER:

Few investors choose a non-deductible IRA to invest their capital in, which is why this retirement plan is not very popular. Typically, individuals open non-deductible IRAs as a last-resort measure, after not being able to qualify for a traditional or a Roth IRA. So you should think twice and consider other options that might be available to you before opening a nondeductible IRA.

Disadvantages of a Non-Deductible IRA

While under a Roth IRA, your distributions are tax-free after reaching a certain age, and a traditional IRA has the advantage of tax deduction of the contributions during the accumulation period, a non-deductible IRA is a lot like a traditional IRA without the tax deduction option. This means that you have to pay tax on both your regular contributions and on your distributions from the retirement account. Most investors are put off by the fact that non-deductible IRAs share some features of both traditional and Roth IRAs, without providing the tax benefits of any of these retirement plans.

Benefits of a Non-Deductible IRA

Non-deductible IRAs might not have deductible contributions, but they provide tax-deferral. If, for example, you invest in bonds, you might earn a significant sum of money even after you have paid taxes on the IRA withdrawal. In that case, a withdrawal before age 59.5 is subject to an early withdrawal penalty amounting to 10 percent of the distributions.

That is not the case with stock investment which has proven to yield less earnings. This is due to the fact that, even though stocks provide some tax advantages, non-deductible IRA withdrawals are taxed at regular rates. Furthermore, even if the stocks increase in value, you might as well just keep the shares in a regular taxable account without the hassle of opening a non-deductible IRA.

When to Consider a Non-Deductible IRA

  • If you have reached age 59.5, you can make withdrawals without penalty. Furthermore, you can ease the tax burden as long as you choose investments that make the most use of the tax-deferral value.
  • If your income is too high (over $100,000) to qualify for a traditional or a Roth IRA, and you are covered by a retirement plan at work.
  • If you income is too high, you can set up a nondeductible IRA which in 2010 you can convert to a Roth IRA. In 2010 income limits for conversion to a Roth IRA will be liquidated.
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