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I have what I thought would be a simple question and/or confirmation of my understanding.
My family (wife and I) are considered high income (not complaining) and here is the summary of our yearly investing approaches.
* both of us max out our 401K and have some left over
* We have a mortgage, but no other debt
* We are probably in the higher (if not highest) income bracket
* We have some IRA's from previous rollovers and from our younger days
* We are both just under 40
* With our 401K's maxed we still have about 25+K each year available to invest

My simple question:
* Why wouldn't we still fund our traditional IRA's each year with the max amount allowed (5K for each of us)? These are IRA accounts we have with Vanguard and so we can invest the $ however we want (except for trade types not allowed with IRA's).
My reasoning is that even though we can't deduct the 5K, we already "paid" taxes on it and so if I can at least get it into a tax deffered account I wouldn't have to pay tax on the earnings year in year out going forward.
Also, I know there are calculators out there about whether or not to convert a IRA to a Roth IRA. My simple thinking would be do it (if I can pay the taxes on it) as everything I gain on the money for the next 20+ years will never be taxed. Even though it could be a hefty tax bill, it would seem that paying the tax once (now) would be better. I know that if my tax bracket is lower in retirement than now, I might not pay AS MUCH in tax, but the difference between the amount I pay now vs the amount I pay later would be more than offset by the gains I would make on that "been taxed now and never taxed again money".

So, is there a reason that I A) wouldn't put something into the IRA every year even if I have already maxed out my 401K and B) Wouldn't convert what I have now and what I had every year from a traditional IRA to a Roth IRA?
In all of these cases this is money that I don't need or plan to touch until retirement.

Sorry for what is probably a question that has been asked many times, I just never felt I had a clear understanding as the math seems pretty straight forward to me (maybe I need to break out an excel spreadsheet and run some examples for myself).

Thanks,
Daver
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Should you contribute the max after tax amount each year to you and your spouse' IRAs? Absolutely.

Your concern will be saving enough through traditional retirement plans. Do either of you have access to an employer deferred comp plan?

BruceM
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Daver, yes, yes, and more. Feed both IRA's. I am in a similar situation, lower income but enough to contribute to both every year.
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Yes, contribute to the IRA even though you can't deduct it. Then, if you wish, invest/save via a taxable account. IMHO, it is best to have a little in each of the various tax advantage/taxable accounts. With the constantly changing tax laws, it won't give you the best tax outcome, but it won't give you the worst either. And you have the flexability of where you want to with drawl from in the future.

JLC
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i say 'no'

putting after-tax money in IRAs means accounting 'nightmares' ..

if you're like me --by age 70, you won't be nearly as good at arithmetic.




converting to Roth also likely a bad idea at this point ..sounds like your tax rate will be much smaller after retirement.
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i say 'no'

putting after-tax money in IRAs means accounting 'nightmares' ..


I can't comment on what others consider an accounting nightmare - that might include balancing a check book. But if Quicken is not something you want to mess with, here is a very simple way. Put all your Post Taxed IRA funds in a single, different account. Could be at the same brokerage used for your traditional IRA or and a different financial institution.



Gordon
Atlanta
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Putting all the taxable contributions in one account doesn't help. When you begin withdrawing, the taxable amount is based on the total of ALL IRAs.

Nice thought, but it doesn't work. Sorry.

Best wishes, Chris
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Chris I don't understand what you are talking about. Yes when you withdraw your total with draw must be based on all non-Roth IRAs. But there is no requirement you take funds from all your IRA account. Just the total amount. Second all funds from a traditional IRA will be taxes as ordinary income. That is simple. Funds from an after tax IRA are taxed like any other investment account - so I see no great complexity with using a separate account and it does have the benefit or "labeling" withdraws as not 100% taxable.

Gordon
Atlanta
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and it does have the benefit or "labeling" withdraws as not 100% taxable.

After you make a non-deductible traditional IRA contribution, ANY withdrawal from ANY traditional IRA becomes partially non-taxable.

--Peter
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Peter thank you for the education. Obviously I just got lucky when I made a decision long ago to do Traditional IRAs only -- other retirement funds I put into an investment account. My rational was diversification of investment vehicles.

Gordon
Atlanta
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Read the instructions on the tax forms concerning IRAs. Annually you report the TOTAL amount in IRAs. When you start making withdrawals, it asks for the amount withdrawn from IRAs. There is a line for the basis, which is the amount of after-tax contributions. The % of the withdrawal which is taxed is calculated using these figures. At no point are you given the opportunity to say "this IRA is after tax and that one is before tax". You have to lump all of them and do the calculations. Each year the basis changes and you have to keep track of it. Each custodian of your IRAs must note the value of your account each December 31 and report that figure to you, and to the IRS.

It would have been much nicer if one could do as you suggest, but that isn't the way they set it up.

Best wishes, Chris
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Read the instructions on the tax forms concerning IRAs. Annually you report the TOTAL amount in IRAs. When you start making withdrawals, it asks for the amount withdrawn from IRAs. There is a line for the basis, which is the amount of after-tax contributions. The % of the withdrawal which is taxed is calculated using these figures. At no point are you given the opportunity to say "this IRA is after tax and that one is before tax". You have to lump all of them and do the calculations. Each year the basis changes and you have to keep track of it. Each custodian of your IRAs must note the value of your account each December 31 and report that figure to you, and to the IRS.


when i was 50, that all sounded "more trouble than it's worth" (could be wrong ...since there was no TMF etc)

now i'm 65 ,no where near as smart as i used to be and it sounds like "accounting nightmare" <g>


but each to their own.
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0x6a74 writes,

Read the instructions on the tax forms concerning IRAs. Annually you report the TOTAL amount in IRAs. When you start making withdrawals, it asks for the amount withdrawn from IRAs. There is a line for the basis, which is the amount of after-tax contributions. The % of the withdrawal which is taxed is calculated using these figures. At no point are you given the opportunity to say "this IRA is after tax and that one is before tax". You have to lump all of them and do the calculations. Each year the basis changes and you have to keep track of it. Each custodian of your IRAs must note the value of your account each December 31 and report that figure to you, and to the IRS.


when i was 50, that all sounded "more trouble than it's worth" (could be wrong ...since there was no TMF etc)

</snip>


I've been making SEPP withdrawals from an IRA with after-tax contributions for about 15 years. It's not a problem. Turbo-tax can handle it and keeps track of the remaining tax-paid basis from year to year.

intercst
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Chris I turn 70 late in 2011, so I have not into the required withdraws. And since I only have traditional IRAs, I expect it will be just do the RMD. My funds are with Schwab. Based experience with another person's funds, Schwab calculates the RDM and has a very simple system for accomplishing the withdraw.

Gordon
Atlanta
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I agree with one of the prior comments about it being good to have you assets in a mixture of account types for flexibility and to be adaptable for future tax law changes. If you don't already have a significant percentage of your net worth in taxable account then it would be good to save up more in the taxable accounts for diversification.

....So, is there a reason that I A) wouldn't put something into the IRA every year even if I have already maxed out my 401K and B) Wouldn't convert what I have now and what I had every year from a traditional IRA to a Roth IRA?...

It wasn't completely clear but it sounds like you are talking about what is called a "back door Roth". If you google this term then you will find lots of information like this.

http://online.wsj.com/article/SB1000142405274870365760457500...

The non-deductible IRA's that are not converted to a Roth have at least three major drawbacks.

1) If you retire early your ability to withdraw the money without a penalty is restricted.

2) They will be taxed at your ordinary tax rate, instead of the capital gains tax rate.

3) If the alternative is owning stocks, then if the stock goes to your estate or gifted to a charity it will be at a stepped up cost basis and the capital gains taxes will never have to be paid.


Greg
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I've been making SEPP withdrawals from an IRA with after-tax contributions for about 15 years. It's not a problem. Turbo-tax can handle it and keeps track of the remaining tax-paid basis from year to year.



just sayin' ..stuff happens.

when i started there was no TurboTax ..
and there was one year i couldn't use Turbotax .. remembering and finding all the year-2-year stuff was a pain.


don't know SEPP ..in that case, the bookkeeping might be necessary.

with IRA, it really isn't ... BUT may be worth the trouble and i just don't see it.
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BUT may be worth the trouble and i just don't see it.

What trouble? You keep track of your non-deductible IRA contributions. That strikes me as some fairly basic addition that most third graders are well-equipped to handle.

You also have to know the value of your IRA accounts. If you have more than one, you'll need that third grader again to handle the addition for you.

Then you divide those two numbers into each other. I realize this might require a 5th or 6th grader, as long division is a bit of higher math. That division will give you a decimal fraction between 0 and 1.

Next, multiply your withdrawal by that fraction. This will again require the services of that 5th or 6th grader, so be sure not to lay them off the payroll until you get both bits of math out of them. And make sure they round the result off to the nearest whole dollar. The result of this multiplication is the amount of the withdrawal that is not taxable.

Finally, you'll need the 3rd grader back to do some subtraction. Subtract the non-taxable withdrawal from the remaining balance of your non-deductible contributions. That's what you get to take out tax free in future years.

I've tried to make this as complicated as I could. I still don't see an accounting nightmare. It does require the responsibility to keep track of things from year to year. The IRS even helps out with this as everything you do need to track from year to year is on Form 8606 which is a required part of your tax return any time you make a non-deductible contribution or a withdrawal from an IRA after you made a non-deductible contribution. That's one lousy piece of paper (or two if you don't print on both sides) that you have to keep track of from year to year.

--Peter
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I don't think this was covered in the thread .. is there any reason you cannot leave what you have in place and open a new Roth IRA as opposed to making after tax contributions to the traditional IRA or converting tour traditional IRA.

The advantages of the Roth are many-fold ... you would be stuck for the taxes on additional contributions anyway, but the big advantage is the back end. There is no RMD on a Roth. You can make adjustments whenever without tax consequence after age 59 1/2.

This wouldn't cover all your "extra" disposable income, but that can go into your Schwab account. It always rains sometime some place. I suffered (for example) about $3000 in damage from ice damming last winter. It was nice not to have to scramble for funding repairs.
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What trouble? You keep track of your non-deductible IRA contributions. That strikes me as some fairly basic addition that most third graders are well-equipped to handle....
I've tried to make this as complicated as I could. I still don't see an accounting nightmare. It does require the responsibility to keep track of things from year to year. The IRS even helps out with this as everything you do need to track from year to year is on Form 8606 which is a required part of your tax return any time you make a non-deductible contribution or a withdrawal from an IRA after you made a non-deductible contribution. That's one lousy piece of paper (or two if you don't print on both sides) that you have to keep track of from year to year.


It is an accounting nightmare, despite anybody's fancy handwaving that it isn't.

"Any 3rd grader"?? Right. How about when the 3rd grader is now 30 years later in life, has moved 5 times, born & raised 3 kids, has been laid off & hired a few times, perhaps gotten divorced & remarried, and is now in his 5th year of retirement. Oh, and it has been 20 years since the last time he has needed to file form 8606, and now realised that he probably shouldn't have tossed out all of his ancient tax forms 10 years ago.

All for a trivial benefit.
Consider the case where you've made $5,000 in non-deductible IRA contributions. But now at retirement your total IRA accounts amount to $250,000, and you have an RMD of $9124.

2% of that is non-taxable (5000 / 250000), and 98% is taxable.
Non-taxable amount is $182. Being retired and therefore in the 15% bracket, the tax savings is $27.
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Ray - if it's too hard for you, that's fine. But for some people, it's not too hard. And they'd like the benefit of the tax deferral on the earnings for 10 or 20 or 30 years.

--Peter
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Ray - if it's too hard for you, that's fine. But for some people, it's not too hard.

I didn't say it was hard, I said that in real-life keeping track of one small piece of low-importance data over several decades is difficult to pull off. And that even if you do pull it off, the real-world actual cash value of the benefit is trivial.

And they'd like the benefit of the tax deferral on the earnings for 10 or 20 or 30 years.

Tax deferral is fine, but the tax isn't avoided it's merely deferred. And there are better (and simpler) ways to get an even larger tax benefit.

Instead of putting after-tax money into an IRA, put it into an S&P500 index fund, and don't make any withdrawals until you retire.
Then the withdrawals will be at capital gains rate instead of ordinary income rate.
Even better, if you are in the 15% tax bracket in retirement there are NO capital gains tax (currently, with the Bush tax cut in effect--unless & until they stop renewing that).
Oh, and no RMD since it's not in an IRA.
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(currently, with the Bush tax cut in effect--unless & until they stop renewing that)



+++
+++


Betchya believe in the Easter Bunny too!


sunray
a man with more pragmatic/pessimistic views






{& all Roth accounts ;-)}
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dhartman wrote: <<So, is there a reason that I A) wouldn't put something into the IRA every year even if I have already maxed out my 401K and B) Wouldn't convert what I have now and what I had every year from a traditional IRA to a Roth IRA? >>

As far as question A goes, I think your best option for new IRA contributions is a "backdoor Roth IRA." Watty56 already noted that the "backdoor Roth" option is open to you going forward. Here's another link that talks in detail about the "backdoor Roth:" http://thefinancebuff.com/the-backdoor-roth-ira-a-complete-h...

Note that for this to work with the smallest tax bite, you need to clear any before-tax $$ from your IRA by transferring it to either your employer's 401K or a self-directed 401k of your own, leaving only after-tax $$ in the IRA. Then you can rollover w/o any taxes.

WRT question B, converting your Trad IRA to a Roth you state: <<* We are probably in the higher (if not highest) income bracket>> You need to consider your current vs future marginal tax rates, including state taxes,, before making a decision.
You're in the 35% bracket now but you don't mention any state income taxes. Worst case, a NY or CA resident might be facing an additional 8-10% tax on the Roth conversion income, for a haircut totaling 43-45% of what you converted. Ouch!
Compare that to converting to a Roth in retirement after you move to Florida or TX or another of the states w/o an income tax. The 28% bracket maxes out around $210K taxable income. Assuming you & the missus can scrape by (lol) on $150K of taxable income, that leaves about $60K of Roth conversion $$ that you can use to fill up the rest of the 28% bracket each year. Assuming you retire early at 55, that lets you convert ~$60K x 16 years = $960K before reaching the age for RMDs. Why would you pay 35-45% to convert now, when you can do it later for much, much less?
YMMV & future tax brackets are bound to change, obviously, so plug various scenarios into the mix.

Chris
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Yep, I "backdoor ROTH IRA" was exactly what I was thinking. I guess I just like the idea of paying tax now and not paying any later. Even if the tax rate is higher now than later, I pay no tax on the gains, which if I'm 20+ years away I expect I will have some.

Thanks for the feedback.
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