Is there a point to contributing to a nondeductible traditional IRA?

Question

I, 24 y/o US citizen employed in the US, make over the 137k cut off for making contributions towards a Roth IRA. As a result, I have considered contributing to a traditional IRA.

However, I am not sure if this is a good idea. Should I be maximizing my traditional/Roth 401k contributions before I even consider a traditional IRA? Is there any sense in contributing to a traditional IRA if the 401k contribution isn't maxed? My research shows no, but I'd like to make sure I am not misinterpreting the benefits.

Answer 1

There are at least two reasons to contribute to an IRA:

1. A backdoor Roth IRA. You can still get your money into a Roth IRA to grow tax free. However, there may be some pitfalls.
2. Deferred tax on growth. If you're deciding between traditional IRA vs. taxable account, the benefit is that the growth (dividends, interest, capital gains) aren't taxed until withdrawal (although your income/contribution is taxed now). If you expect to be in a low tax bracket at the time of withdrawal, this could save you some money on your tax bill.

However, since you're income is too high to be eligible for a Roth IRA, you won't be able to deduct contributions on your taxes (the limit for deducting traditional IRA contributions is lower than Roth eligibility limit). You should definitely maximize your contributions to your workplace plan, where you can deduct from your taxes (or even contribute to a Roth account if your plan allows).

Answer 2

You need to determine how much you need to put into your retirement accounts this year, and then decide on the best split that gets you to your goals.

Should I be maximizing my traditional/Roth 401k contributions before I even consider a traditional IRA?

You should put enough money into the 401(k) to get the maximum company match. Then decide if you can get better investment options or lower costs by using an IRA instead of the 401(k)

Is there any sense in contributing to a traditional IRA if the 401k contribution isn't maxed?

That comes down to cost and options. If the options in the 401(k) are poor, or are very expensive, then the IRA may be best. You have to decide if you can't do a deductible IRA then does the option for the backdoor Roth make sense for you.

You have to map this out before deciding how much to contribute via payroll deduction.

Answer 3

Once you have gotten the maximum matching on the 401k, further contributions to the 401k are just like deductible IRA contributions. They reduce your taxable income this year and are not taxed until the money comes out. You may even roll them over to an IRA in the future if you change jobs. The advantage over the nondeductible IRA is the money that would have gone to pay taxes is in the account earning returns. You get to keep the posttax fraction on those returns. As others have said, look at the fees an options in the 401k, but this is a strong incentive to contribute to the 401k.

Once you hit the 401k maximum, you may find it makes sense to do a nondeductible IRA as well. Especially when you are young the deferral of taxes on gains is powerful. The money you put in becomes your basis and it comes out tax free. The earnings are taxed at withdrawal. As you get older and there are fewer rollovers of gain before withdrawal, the fact that long term capital gains are taxed at a lower rate than ordinary income matters more. You may want to have interest bearing things in the IRA and capital gains things in a taxable account.