Non Retirement Mutual Funds vs After Tax Traditional IRA [duplicate]

Question

I have two separate accounts. One has non-retirement mutual funds invested in Index Funds and another is an after-tax traditional IRA retirement account invested in funds like media, communication, and new horizon.

Since I am contributing to a traditional IRA after taxes, do I get any benefit from it? Would it make any difference if I don't contribute to my traditional IRA and put all the money in Index funds account?

Capital gains tax from non-retirement account will be 15% for me.

When I take money out from traditional IRA, I will have to pay income tax on my income for that year which might be more than 15%.

Does an after-tax traditional IRA have any advantage over non-retirement mutual funds?

Location: USA Status: Married filing jointly Yearly income: 200K+

Answer 1

Yes, there are two key advantages:

1. The first is that taxes (on the gains) are deferred until you actually withdraw them from the account. You can buy/sell as much as you want and not incur taxes. Additionally, dividends and capital gains paid out by your investments won't be taxed. If you strategically plan withdrawals for years when you have little income, you could pay very little (or no) income tax. Note that the tax applies to the gains only - since you've already paid tax on your contributions (before contributing), they are not taxed again; the complicated part is that every withdrawal is mixed between pre-tax and after-tax money.
2. You can convert it to a Roth IRA, where it will never be taxed. This is known as a "backdoor Roth". The after-tax contributions themselves are not taxed, but any gains between contribution and conversion are (if you convert immediately, you can minimize/avoid having gains in the conversion). The hang-up here is that the conversion is pro-rated between pre-tax and after-tax money across all of your existing IRA balances; if you have an existing and well-funded traditional pre-tax IRA, you'll take a tax hit, and this approach may or may not be worth it. If you have no existing pre-tax IRAs, or if you can roll over such balances into a 401(k) plan, this is a convenient way to boost your Roth account.

There are two primary disadvantages, one of which you mentioned already:

1. Capital gains have a favorable tax rate (potentially as low as 0%, depending on AGI at the time the gain is realized). While gains are not taxed at all inside an IRA, you'll eventually need to take the money out, and then it will be taxed as ordinary income, potentially (much) higher than LTCG rate.
2. If you already have pre-tax money in your IRA (any IRA - the IRS considers them all together as one), mixing in after-tax money complicates things like withdrawals and Roth conversions in terms of how much is taxable. It's basically polluted with a mix of different tax liabilities forever until you empty all your IRAs.