2008/2009 NonDeductible IRA Contribution Decisions

With the market in another funk this week, I was reminded that I had until April 15th to make my IRA contributions for 2008. It could get worse before then, or it might bounce up again, I have no predictive powers either way. I don’t like to be wishy-washy, so we went ahead and each invested $5,000 to a non-deductible IRA today.

Background
A nondeductible IRA is the same as a Traditional IRA, except that your income is too high so you can’t deduct the contribution. If you haven’t maxed out all your other options like a deductible Traditional IRA, Roth IRA, 401(k), or 403(b) plan, you should put your money towards those first. This option is mostly for those with no other better options.

Why?
So if you don’t get the tax deduction, what’s the point? The most appealing is that in 2010, unless the law is changed, you can start rolling over your non-deductible IRA into a Roth IRA with no income restrictions. I am starting to like my chances, since we are only ten months away from 2010 (I plan to convert right away) and I’m sure with the current deficit the government would like to collect all the tax revenue it can now instead of later. If it looks good, I’ll probably make my 2009 contribution in December (after making sure we don’t otherwise qualify) and convert that to a Roth too.

The second reason is that the after-tax returns might be higher if you invested in tax-inefficient products like bonds, commodities, or REITs.

Contribution Limits
The contribution limits are $5,000 for both 2008 and 2009. If you are age 50 or older, you can contribute another $1,000 that year.

What Did I Buy?
My portfolio is getting out of whack right now, so I bought what I need to bring it back into my desired asset allocation. I purchased $3,000 of an REIT fund (VGSIX), $2,000 of a US Small Value fund (VISVX), and $5,000 of an Emerging Market fund (VEIEX). We’re still making regular contributions to our 401ks, which contain our US and International “Total Market” funds.

Comments

  1. Very interesting and timely information. I had no idea about all the changes coming in 2010. Still with the stock market the way it is does anyone think investing in it is a good idea?

  2. Ian – let your own risk profile decide that, if you couldn’t stomach s&P at 400 in 2010 and would sell, don’t do it, we all know now it could happen.

    Nevertheless, the Nondeductible to Roth conversion plan still is a no-brainer (assuming you don’t have any tax deductible place to put the funds), even if you just put it in a money market in the IRA. If there is a time you feel more comfortable with the market, you can invest it then. Either way, You’ll never get the opportunity to go back and put that $5K in if you tend to max out your contributions every year, and there is no point paying tax on the interest from your money market or the cap gain from your stocks if you don’t have to.

  3. You certainly have to feel better about making your contributions this year as opposed to last. I would say we are closer to a bottom then a top in the market right now. I’m still looking for an L shaped recovery, I do not see what catalyst would propel this market much higher.

  4. One more thing to note. Even if the rollover option is not around in 2010, you still are not taxed on the contribution amount when you take it out in retirement with a non-deductible IRA. You will be taxed on the earnings though. Just make sure you keep track of your non-deductible contributions on IRS Form 8606.

  5. Clarification: You don’t have to be 50 in 2009 to contribute the extra $1,000 into a Roth IRA. You only have to be turning 50 sometime during 2009.

    So if you are age 49 but you don’t turn 50 until Sept. 1, 2009, you can still make that extra $1,000 contribution at anytime during the year.

  6. I’m betting the law will be changed before January, or shortly thereafter. It’s really a gaping loophole that I don’t think was intended by anybody back in 2006 when the current law was signed. There is a maximum income limit for contributing to a Roth, but no limit for contributing to a non-deductible traditional IRA and then converting that to a Roth. Seeing as how that benefits higher-income folks and doesn’t, as far as I can see, increase short-term tax revenues, I think somebody in Washington will notice and plug it up.

  7. Another consideration: if your IRA uses a money market sweep account to settle trades, you could put the money in the account now and choose to buy funds later. My Roth is set up this way – all contributions are automatically directed to a money market fund that is essentially cash until I choose to buy something.

  8. ChrisMR says:

    I really like this blog, but some days, the amount of cash you have on hand to play with makes me a bit sick. A lot of people are scraping to get by, and their financial decisions are much more difficult to make.

    Wish I had $10K to invest as I see fit at the end of the year. We are able to put back about $10K a year total… guess the public sector pay scale has its down side.

  9. Jonathan — I know you were thinking of your asset allocation, but I think you forgot about your asset LOCATION. With the exception of the REIT fund inside your IRA, all your 401k investments and other IRA investments are with tax-efficient funds. Do you have any taxable/corporate bonds? I think you need to consider moving your bond funds into your IRA if you have any. I’m pretty sure you’re not 100% equities.

  10. All my investments are in tax-sheltered IRAs and/or 401ks right now. Once I run out of room, I’ll be putting the low turnover stock index funds in taxable.

  11. Can I contribute to Roth IRA if I maxed out my 401K? Or is it advisable to create non-deductible IRA.

  12. SuperSaver says:

    I am thinking of investing in commodities in the future to hedge against pending inflation. What’s a good way to invest in commodities?

    How could investing in commodities be tax-inefficient, as Jonathan mentions? They don’t pay out dividends like bonds and REITs, do they?

  13. I do nearly the exact same thing as Jonathan. I have made $5K contributions to a non-deductible IRA the last few years and hope to convert to ROTH in 2010. I’m guessing it will be an entirely free conversion as I’ve already paid taxes on the basis and they are all worth less these days.

  14. Thanks Jonathan – hoping to do the same in 2010.

  15. I agree that (in theory) Strick has a great idea. A non-deductible contribution to a traditional IRA this year (2009) can be converted to a Roth in 2010. However, it is my understanding that the non-deductible contribution must be converted in a ratio with your pre-existing deductible traditional IRA funds. In other words, it is not possible to convert ONLY the non-deductible portion of your traditional IRA. http://invest-faq.com/cbc/ret-plan-trad-ira.html

  16. Correct me if i’m wrong, but if i already have an IRA (a rollover from a previous employer), i can’t just open a new regular IRA and make non-deductible contributions to the new one only; and then expect to convert the new regular IRA to a roth IRA in 2010 w/o paying taxes? Ie, i’m essentially doing a “partial” conversion since the sum total of *all* the IRA’s must be taken into account.

    Eg, if i had 20k in the new regular IRA, all non-deductible contributions, and i had 100k in the old regular IRA (all deductible contributions), and i wanted to convert the 20k to a roth, i would pay taxes on 83.3% of my conversion, since since only 16.6% of the sum total of my IRA’s are non-deductible; is that right?

  17. Is there an income cap (MAGI) to qualify to make contributions to a non-deductible IRA? I know that the Roth IRA caps household income. Does the same income $ apply to the non deductible contribs?

  18. Alicia, there is no income “test” if you’re making a non-deductible contribution. As long as it’s earned income, you can contribute up to the max allowed.

  19. Ali Hashemian says:

    Gil,

    That is correct. With IRAs you must convert a proportionate amount of all your accumulated IRAs. So you example is correct. However, this is not the case with old 401(k)s that have an after-tax (or non-deductible) portion to them. Using IRS guidelines, those monies can be seperated and diverted to traditional and Roth IRAs accordingly. If you want to discuss, email me. AliHashemian@gmail.com

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