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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75810  
Subject: Re: Non-Deductible IRA Strategy Date: 3/18/2001 11:39 AM
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melrosest asks,

Hi intercst-

I am very interested in your answer to point #2. Here you are recommending that instead of making non-deductible contributions to an IRA one should use a tax managed index in a taxable account. Is this assuming that when you would withdraw from your IRA that you would be in the highest tax bracket? Do you know where the breakeven tax bracket would be where it would become more advantageous to make the non-deductible contributions to an IRA instead? Does your comment also take into account the cap gains tax on distributions that a tax managed index fund would realize however small they may be?

I am in this exact situation and am trying to determine which I should do. I have no idea what my future tax bracket may be in retirement. Given that, should I lean one way or the other?


As jkrou explains above, no matter what your tax bracket, long-term capital gains are taxed at a lower rate than the ordinary income tax you pay on an IRA distribution.

Gus Sauter, manager of Vanguard's index fund operations has said that there would not be any capital gains distributions from the Index 500 fund until more than 40% of the asset value of the fund is redeemed. It would take a major panic for anything like that to happen. The odds are very good that you'll never see an involuntary capital gains distribution from a Vanguard tax-managed index fund.

You will pay income taxes on the dividend income from index fund. The Index 500 fund currently has about a 1% yield, so at the 28% tax bracket, you'd only pay about a quarter of 1% of the asset value of the fund in taxes. That's not much more than the 0.17% expense ratio of the fund, and it pales in comparison to the difference between ordinary income taxes and capital gains taxes on the distributions.

intercst

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