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I am in the United States and I earn an income in the range of $200k/year. I am single with no kids and generally keep my overhead expenses low (car is paid off, my housing cost is very reasonable, etc.).

For retirement, I max out my 401k to the IRS limit and my employer does matching. My income allows me to have extra funds to invest and I realize that the next logical step is an IRA. However, I don't like the thought of my money being locked up for a long time and - if I understand IRAs correctly - I'm not gaining a tax advantage, I'm just deferring them, "kicking the can down the road". So, is there a case against having an IRA? Why not just keep a standard brokerage account and just keep the funds available for retirement or my own business or whatever else I want? What am I not seeing here?

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    Deferring taxes is a tax advantage. You get to invest the money that you'd otherwise pay as taxes, giving you a higher return. Aug 30, 2021 at 13:13
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    The idea of deferring taxes is that (besides skipping tax on capital gains & dividends) you expect to be paying a lower tax rate when you take money out. That is, if you're making $200K/yr, what you earn over $163K is taxed at 32%. Simplistically, as a moderate spender, you'd probably take out less than $85K/yr, so that money would only be taxed at 22%, giving you an extra $8500. (Of course it's rather more complicated, given marginal rates, other income, and so on, but this shows the principle.)
    – jamesqf
    Aug 30, 2021 at 15:26
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    Everyone always talks about ROTH'S and IRA's and 401K's etc...don't forget to put away a LOT of money that you do not want "Locked Up". I don't know your goals or your age rigth now. Maybe you want to retire at 50? Or heck maybe you're young and you want to retire at 40? I don't know...but if you plan to do that make sure you actually have money saved outside of these traditional accounts. This way you can live off your savings rather than assessing fees from your retirement accounts. Me personally with your income level you should have both a 401k and a roth ira as well as savings.
    – JonH
    Aug 30, 2021 at 16:07
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    @user253751 -- assume 15% tax rate. Invest $85 (after taxes) for a year at 10%, gain $8.50. Taxes on that $8.50 leaves $7.23 gain and $85 principal. Invest $100 (before taxes) for a year at 10%, gain $10. Taxes on that $10 leaves $8.50 gain, pay taxes on that $100 leaves $85 principal. Bottom line: deferring taxes (all other tings being equal) results in larger gains because you get to invest the money that you would have paid in taxes. Aug 31, 2021 at 13:44
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    @user253751 -- I was talking about deferring taxes in general, not necessarily in a tax-advantaged retirement account. Aug 31, 2021 at 14:29

6 Answers 6

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At your income level you can't make deductible contributions to a traditional IRA and you can't contribute directly to a Roth IRA, but you can make a backdoor Roth contribution.

In a Roth IRA your gains grow tax-free and you don't pay tax on distributions (because the contributions were made with money that was already taxed). Also you can withdraw your contributions at any time without penalty (conversions after 5-years if utilizing backdoor). Significantly better than a standard brokerage account. Most people prioritize funding their IRA ahead of maxing out 401k contributions.

A Traditional IRA (for those that can make deductible contributions) could feel like it's just kicking the can down the road, but most people have a lower tax rate in retirement than during their career so they pay less tax when using a pre-tax contribution now. The unknown is what changes to tax code/tax rates may occur between now and then. Many prefer having a 401k and Roth IRA so that they can strategize withdrawals based on tax situation.

Also, while IRA's aren't just kicking the can down the road, the idea of deferring taxes shouldn't be dismissed as having no value. Businesses love to take special depreciation when they can (front-loading expenses) and 1031 exchanges are very popular with landlords because having more cash available today is preferred to having the same amount of cash available later on.

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    ... The key advantage of either type of IRA is that assets are only taxed once -- there's no separate tax on the growth in the assets (capital gains and dividends) as there is for standard accounts.
    – nanoman
    Aug 30, 2021 at 3:11
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    Paragraph 3 implies that if the tax rate is the same in retirement, then it is can-kicking. Then paragraph 4 implies that inflation actually makes this can-kicking favorable -- but it's a rate, not a fixed dollar amount, so there is no need to adjust for inflation. Paying 25% of your assets now or 25% of your assets later is a wash regardless of inflation.
    – nanoman
    Aug 30, 2021 at 3:45
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    Additionally: Amounts that go into a backdoor Roth IRA are not contributions but conversions, and they can only be withdrawn penalty-free starting 5 years after the conversion, not "at any time".
    – nanoman
    Aug 30, 2021 at 3:59
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    @HartCO But the choice here isn't between 25% of $5k today vs 25% of $5k in 20 years. The choice is between the 20-year growth on 25% of $5k vs 25% of the 20-year growth on $5k. That is the reason it's a wash: no matter the growth rate, you end at the same total amount of dollars 20 years from now. In fact this makes kicking the can worse than not, because by kicking the can you cannot access the dollars next year if there's an emergency. Aug 30, 2021 at 15:41
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    @Daniel Wagner: The choice isn't even between 25% today vs 25% sometime in the future. It's between (for the OP) 32% today vs maybe 20% in the future. Since the OP has excess money to save, s/he will probably withdraw less per year than current income, so be subject to a lower tax rate.
    – jamesqf
    Aug 30, 2021 at 22:12
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Here's what you're missing: In a "standard brokerage account", in addition to having already paid income tax on the money you invest, you pay tax on the growth of the investments (dividends when you receive them and capital gains when you sell). The additional tax on growth is what IRAs avoid.

Now, you might have read (correctly) that in your case, with a fairly high income, you cannot take the most common and obvious routes to a tax-advantaged investment -- a Roth IRA contribution or a deductible traditional IRA contribution. However, as Hart CO noted, you can implement a backdoor Roth IRA.

While the backdoor Roth comes with some restrictions and complications compared to direct Roth contributions, it shares the advantage that if you make qualified withdrawals in retirement, you pay no tax on growth.

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    For a Traditional IRA one is still taxed on the gains (eventually). But I believe that for both Roth and Traditional IRAs one never pays capital gains taxes, whereas a "standard brokerage account" requires the payment of capital gains taxes. By my understanding, the long-term benefit of either IRA type over the "standard brokerage account" is approximately equal to the capital gains tax rate.
    – Pred
    Aug 30, 2021 at 19:57
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Depending on your age and investment style, you are very likely to achieve financial independence well before normal retirement age by maxing contributions.

One pitfall to such a plan is to take money out of your retirement accounts to use for other purposes. You don't sound like such a person, but it is important to realize.

So in my opinion you should open up a standard brokerage account. You can invest in a low cost index fund which should have very little tax consequences. This way if you need 100K for some large purchase, you will have it and not try to figure out how to tap your retirement accounts.

Sure you will likely owe some taxes on such money, but it will be at a much lower rate then one who taps their retirement accounts and you keep your future secure.

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I am in the United States and I earn an income in the range of $200k/year. I am single with no kids and generally keep my overhead expenses low (car is paid off, my housing cost is very reasonable, etc.).

For retirement, I max out my 401k to the IRS limit and my employer does matching. My income allows me to have extra funds to invest and I realize that the next logical step is an IRA.

I am assuming several things, that you have fully funded your emergency and life happens funds. I also assume that you are fully protected via disability and/or long term care insurance.

While you say you are hitting the 401(k) annual limit, you haven't said that the annual limit plus Social security and previous retirement funds will be enough to fund your expected lifestyle in retirement.

If you need to put aside more retirement money then the backdoor Roth would be your only option based on your income level and your participation in a 401(k) program.

While you certainly can put funds into a regular brokerage account, the use of a retirement account for funds that you will be using in retirement does allow you to sell investments without the obligation to pay for capital gains now. Retirement accounts also avoid the requirement to pay taxes now for dividends earned.

Yes maximizing IRA contributions in addition to maximizing 401(k) contributions isn't important if your 401(k) account will get you to where you want to be.

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At $200k/year income you're not deferring taxes!

With the 401(k) and your income, you are not eligible to deduct your contribution to a traditional IRA.

What you are actually creating is a Non-Deductible IRA (NDIRA). That's not a third kind of IRA, merely a treatment of a traditional IRA.

You will not be taxed twice. You won't owe more tax on the amount of your contribution to an NDIRA, however, the appreciation will be taxed. So for instance if you invest $5000 and have earned $45,000 in gains by retirement, you will only pay tax on 90% of the money. *Remember this point, as we're about to take a turn into "super stupid".

Your best bet is to do a Roth Conversion of the NDIRA. Normally you need to pay income tax on a Roth conversion. But since you already paid tax on the principal, you'd only need to pay tax on any appreciation, e.g. $300 gains so far.

So you might as well be in a Roth.

In a Roth, appreciation is not taxed. And since you already paid tax on Roth contributions, those aren't taxed (again). So if you invest $5000 and in retirement it's had $45,000 gains, you only pay tax on NOTHIN'!

Again:
NDIRA: principal not taxed again. Gains taxed.
Roth conversion: Principal not taxed again. Gains not taxed EVER.

Cost to convert NDIRA to Roth: next to nothing.

Converting your NDIRA to a Roth is the very definition of a "no-brainer" lol.

This whole thing is called the Roth Backdoor, and was specifically authorized by Congress. For tax advisors, there was some uncertainty on this point, since it was done with virtually no recorded documentation other than the law itself. However in later years, both Congress and IRS mentioned it in passing in documentation, and so it is clear both consider it to be law.

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You are right, there are a number of reasons why someone would keep money out of retirement accounts in general. If you think you'll need the money before 59 1/2, it's a bad idea to sock it away in an account that will charge a penalty to get it out before then. You might need it for living expenses for an unexpected job loss or health emergency. You might want to buy a house or start a business with it. You might be planning to retire before 59 1/2.

If you invest in passively managed stocks, the capital gains / dividend tax is going to be small compared to your current marginal rate. From a pure rate of return standpoint it's not going to beat a tax-advantaged account, because as after-tax money you'll still pay something in taxes, no matter how tax-efficient your investment choice. But you'll have the flexibility to do what you want with the money, which can be worth a lot depending on your goals for it. But once you have your retirement decently in hand I think it's pretty common to see it recommended that you build up some after-tax investments. The fee-based planner we saw described it as three legs of a stool. You want pre-tax (401k/403b), tax-free (Roth IRA/Roth 401k), and taxable (ordinary brokerage account). And of course your investment choice should be compatible with both your personal tolerance for risk and how long in the future you think you'll use the money.

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    "buy a house" is specifically a permitted use of IRA funds, in addition to retirement.
    – Ben Voigt
    Aug 31, 2021 at 17:25

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