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My wife and I both work and both our employers offer 401K plans. When I first started my job 4 years ago they had a policy that required you to work for 1 year before you could start making contributions to the 401K plan. My wife's company was just 3 months. Therefore, I decided to open up a Roth IRA for myself and I had my wife open one for herself. I'm looking into trying to increase our contributions so we can try to max out all these retirement accounts next year. We file Joint returns and our MAGI is nearing the $193K where Roth contributions begin to phase out.

When that happens my plan was simply to just open up traditional IRAs for my wife and myself and enjoy the $6000 (2019 value) pre-tax contribution for each account. However, during my research I discovered that if your employer has a 401k plan then you can't deduct that $6000 if your MAGI is greater than $123,000. https://www.irs.gov/retirement-plans/2019-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work

Now I'm very confused and with this information at hand I have a number of quesitons:

1.) If a couple filing jointly cannot deduct the $6,000 for each Traditional IRA when they file taxes then is there even a reason to contribute to a Traditional IRA since you've lost the tax incentive? At this point I'd assume contributing to a Roth is the clear choice since you're still allowed to do that until your MAGI is greater than $203,000 and all investment gains are tax free. Otherwise the the Traditional IRA doesn't allow you to deduct your contribution AND your paying the full tax rate on that investment and its gains when you withdraw in retirement.

1b.) My understanding is that during retirement when you withdraw from a Traditional IRA, you report all of that money as income and the IRS will tax you according to whatever the tax tables are at that time. If you contributed to a Traditional IRA but weren't able to deduct the $6,000 in taxes then won't they be taxing you twice for the initial $6,000 investment? Once in the year you initially made the money and again when you withdraw it?

2.) When the day comes that my wife and I exceed the Roth IRA MAGI limit, is there any advantage to opening up a Traditional IRA? Or should I just start investing that money into a separate non-retirement investment account where that $6000 will be taxed at the current rate the year we make it and all investment gains will be taxed at capital gains rates (assuming obviously all gains are considered long term gains)?

  • I think you are forgetting about "tax free growth" for the duration of the IRA. – Morrison Chang Oct 8 at 20:31
  • "However, during my research I discovered that if your employer has a 401k plan then..." For 401k plans, "covered" means that you or your employer must have contributed to it during the year. If there were no contributions to your 401k plan during the year, you are not "covered by an employer plan", though if your spouse did contribute to her 401k during the year, then your ability to deduct your Traditional IRA contributions still phases out at (a higher level of) $193-203k. – user102008 Oct 9 at 7:46
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One option you may have missed is the concept of a back-door Roth IRA. In this case, you contribute to a traditional IRA for the year. As you note, if your income is too high, this contribution will not be tax-deferred. However, you can ask that your traditional IRA be converted into a Roth IRA -- you ask for this conversion to occur immediately after your contribution. End result, you have made a full after-tax contribution into your Roth IRA that can now grow tax-free.

One small caveat, unlike direct Roth IRA contributions, you cannot get to converted contributions penalty-free for 5 years. That is, normally, one can get the money input into a Roth IRA back out consequence free (not any of the earnings that that money may have made, but the original contribution amount), but not if you go through the above backdoor steps.

Also, you will want to file to do the backdoor conversion as soon as possible after the contribution to the traditional, as you will owe taxes on any earnings that money may make.

Edited to soften the strong wording about 'not getting' to converted contributions -- one can 'get' to the money, but unless it has sat for 5 years after conversion, one will pay a penalty to withdrawal those converted funds.

  • "One small caveat, unlike direct Roth IRA contributions, you cannot get to converted contributions for 5 years." I don't think this is true. There is a penalty for a withdrawal of conversions within 5 years only on the part of the conversion that was taxable. In a properly done backdoor Roth IRA contribution, the conversion should be completely non-taxable, and therefore, there should be no penalty for taking out any part of the backdoor contribution within 5 years. – user102008 Oct 9 at 7:49
  • Note the section here on "Penalties on Conversions From a Traditional IRA to a Roth IRA" fool.com/retirement/iras/… I maybe worded it a little too strongly in saying 'you cannot get', I will edit and soften the words. But, the point is that unlike if one can make a regular Roth IRA contribution and can then withdraw that contributed money without paying any penalties, converted funds -- including backdoor converted funds -- need to be held for 5 years before you can perform that same penalty-free withdrawal. – R. Hamilton Oct 9 at 16:10
  • No, like I said, in a properly-done backdoor Roth IRA contribution, you can perform the same penalty-free withdrawal within 5 years, because none of the conversion was taxable. – user102008 Oct 9 at 16:29
  • user102008, I am not going to purport to be a tax lawyer, but that is not what the link I posted in the comment above says. Specifically, example 2 calls out a person who made a conversion from traditional to Roth IRA, but didn't leave the money in the account for more than 5 years. This is further backed up by IRS Publication 590B irs.gov/publications/p590b#en_US_2018_publink1000231065 "Distributions of conversion and certain rollover contributions within 5-year period." – R. Hamilton Oct 9 at 18:12
  • The link you linked to specifically says "Only to the extent that the distribution is attributable to amounts that were includable in gross income as a result of the conversion." The IRS publication also speficially says "You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount)." In Example 2, the entire conversion was taxable (includable in Paul's income). A backdoor Roth IRA contribution involves a completely non-taxable conversion. – user102008 Oct 9 at 19:30
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  1. "is there even a reason to contribute to a Traditional IRA since you've lost the tax incentive? "

Even under a non-deductible Traditional IRA, you would defer your taxes on gains until you retire. However (unless the political situation between now and then leads to tax law changes), your gains will be taxed then at the regular income rate and not the capital gains rate, so this should be an account to hold non-capital-gains parts of your asset allocation (such as master-limited partnerships, REITS, bonds, and some other contenders)

1b. "If you contributed to a Traditional IRA but weren't able to deduct the $6,000 in taxes then won't they be taxing you twice for the initial $6,000 investment? "

Under current law (again, if Congress chooses to change things between now and retirement year, this can change), that's not the case. Mechanically, the IRS Form 8606 has you add up your total year-over-year basis in the nondeductible IRA on line 5; has you calculate the percent of your total value in line 10; calculates the nontaxable portion of that year's distributions in line 13, and has you subtract this from your basis for your next year's return.

  1. "...opening up a Traditional IRA? Or should I just start investing that money into a separate non-retirement investment..."

If you have an asset allocation for an interest heavy or non-privileged dividend heavy asset class like MLPs, REITs, or bonds; or you expect to do a lot of trading or changes, then the non-deductible IRA provides tax deferment advantages. If your investment category was for intended buy-and-hold capital gains, this is not a good vehicle.

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