10

There are bunch of reasons you would be not allowed to take a traditional IRA contribution deduction (income, spouse's 401k can make things difficult, etc).

If you weren't able to take the deduction for the contribution, is there still any reason for you to drop the $5k into an IRA each year?

5

A non-deductible IRA contribution gives you the same sort of benefit as a deductible contribution does, just less of it. In all cases, you are postponing paying taxes on some income until you withdraw it years later. This postponement:

  • Postpones taxes on the income (e.g. interest) earned on your principle over the years. This is beneficial because of the following aspects.
  • Provides income on the postponed taxes over those years. This interest income is income you would not have otherwise ever received.
  • Allows the income to be taxed at your retirement tax bracket rather than the current tax bracket. This might be lower if your retirement income is lower and/or tax rates are lower, but might be higher if the opposite holds. (Also, one gets no benefit from capital gains rates on IRA-generated income.)
  • Allows the postponed taxes to be paid in "cheaper" dollars if inflation has occurred over the years.

The difference is that with a non-deductible IRA contribution one is not postponing a large chunk of current-year taxes, and so does not gain the above benefits on those taxes. One only gains on the taxes that are postponed on the income which accumulates inside the IRA. (With a non-deductible contribution, one does not pay taxes on the contribution a second time when the contribution is withdrawn during retirement, if one keeps proper records.)

  • 2
    It's the last sentence that's the most important: (With a non-deductible contribution, one does not pay taxes on the contribution a second time when the contribution is withdrawn during retirement, if one keeps proper records. – littleadv Aug 5 '11 at 20:02
4

If you are not able to deduct the deposit you should consider an immediate conversion to Roth which would then grow tax free and come out tax free as well.

2

Another, less-obvious benefit is that IRA funds are protected from creditors. If things go bad and you're forced to go bankrupt, your retirement savings are safe.

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