Efforts by the Obama Administration to place restrictions on how much wealth can be accumulated in retirement accounts and to steer private retirement savings into government debt instruments are well under way. But setting aside the risks that IRAs will come with increasing regulatory strings attached and may even be nationalized down the road, and assuming current law only, there are still times when making IRA contributions doesn’t make good financial sense.
The reality is that if you don’t qualify for a Roth IRA or a deductible traditional IRA due to your income, you don’t necessarily gain anything by contributing to a non-deductible IRA. All it gives you is tax deferral. But almost any asset can give you that. You’re not taxed on gains from a stock or a piece of land or a gold coin until you actually sell. By putting a stock that you intend to hold for the long-term in an IRA, you risk incurring penalties for not following all the contribution and withdrawal rules to the letter.
Holding assets outside of the IRA structure gives you more flexibility. It removes the burden of having to check in with Uncle Sam for permission when you decide you want to make a move.
A recent study by Vanguard found that holding financial assets in a regular, taxable brokerage account actually delivers slightly better returns on average than a non-deductible traditional IRA. This flies in the face of the standard advice proffered by many financial planners, who urge their clients to max-out retirement accounts. Vanguard estimates that a yearly contribution of $5,500 into a non-deductible IRA starting at age 30 will yield $353,000 in after-tax value at age 65. The same contributions put instead into a taxable brokerage account can be expected to grow to $361,000 after taxes – an $8,000 improvement over the IRA!
In most cases, a non-deductible traditional IRA isn’t worth the trouble of setting up. In some cases, though, it may be. If you intend to trade in and out of positions, the IRA structure will save you from capital gains tabulations and liabilities (until you actually withdraw funds from the IRA). And if you expect to be eligible for a Roth IRA in the future, you may be able to convert a traditional IRA into a Roth, thus making any gains accumulated within the Roth structure tax-free upon withdrawal at retirement (assuming the government doesn’t renege on its promise).