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I posted this on the Retire Early group, but just found this one and would appreciate more comments.

After doing our 2001 taxes, we decided to open a traditional IRA (as I see others have done). We are not qualified for a Roth IRA so that is out. We also cannot deduct the contributions to the IRA.

Do you have recommendations on IRAs? I have seen Vanguard mentioned here quite a bit. Also, do you think opening an IRA is worthwhile to us? Some have indicated that a regular fund would be better.

Thanks!
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Greetings, Gwlim, and welcome. You asked:

After doing our 2001 taxes, we decided to open a traditional IRA (as I see others have done). We are not qualified for a Roth IRA so that is out. We also cannot deduct the contributions to the IRA.

Do you have recommendations on IRAs? I have seen Vanguard mentioned here quite a bit. Also, do you think opening an IRA is worthwhile to us? Some have indicated that a regular fund would be better.


I'll leave the actual investment to you or to others who may wish to recommend something to you. I will point out, though, that using a long term, buy and hold taxable account invested in the Vanguard S&P 500 or Total Stock Index funds is arguably better than using the identical investment in a nondeductible traditional IRA. That's because under today's tax laws both funds will throw off little in currently taxable dividends in the taxable account, while all gains will ultimately be taxed at a much lower long term capital gains rate than the ordinary income tax rates at which the gains in the IRA will be taxed. That means far more money in your pocket regardless of what tax rate you are in when you redeem those shares in retirement. Therefore, if you believe the lower capital gains rates will persist into the future, then the taxable account will be better for you. OTOH, if you believe that when you finally take those gains only ordinary income tax rates will apply AND you will be in a lower marginal tax rate in retirement, then perhaps the IRA is better.

Regards..Pixy
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I would tend to agree with the other reply about tax-efficient investments (such as a major stock index fund) would probably be better held in a regular (taxable) account--the withdrawals of gains of a non-deductable traditional IRA would be taxed at your ordinary income tax rates, whereas selling stocks or tax-efficient mutual funds that you have held for the long run would be taxed at long-term (or the newer very long term) capital gains rates, which are (under present law) at a lower rate than ordinary income tax rates.

If you have an asset allocation plan that calls for some tax-inefficient investments (such as bonds, a bond fund, or a REIT), it would generally be better to hold that tax-inefficient investment in a "tax favored" account (even a non-deductable Traditional IRA) so that the gains thrown off each year from such investments wouldn't be taxed each year but rather be allowed to grow until you make your withdrawals.

There are other advantages of IRAs that may go beyond just the federal tax laws:

1. Depending on the state laws, funds in an IRA might or might not be protected from creditors.

2. Likewise, money in retirement accounts may be treated differently for figuring financial aid than money in regular accounts. Be sure to look into this if you or your children plan on applying for financial aid--my imperfect knowledge of this is rather dated.

3. If you practice Asset Allocation With Periodic Rebalancing, rebalancing (selling some of one asset to buy more of another asset) would have taxable consequences in a regular (taxable) account, but no tax consequences in a "tax favored" account (such as an IRA). Or if you are an active trader, same story.
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