President’s Budget Proposes Elimination Of Backdoor Roth

[Struggle Toaster]

Just finished reading this fantastic post summarizing the details of a budget that the author believe won't pass:

Kitces - President’s Budget Proposes Elimination Of Backdoor Roth, Stretch IRA, and Step-Up In Basis At Death!

And while the big ticket item in there that people might freak out about is the elimination of the backdoor treatment, there's a more interesting piece at the end of the post, in the 'silver lining' section:

Expansion of the exceptions to the IRA early withdrawal penalty to include living expenses for the long-term unemployed

I wonder how that one would affect FIRE folks :)

edit: the actual proposal is available here: General Explanations FY 2017. The description of the plan starts on page 138 and seems to be not relevant for FIRE purposes:

An individual would be eligible for this expanded exception with respect to any distribution from an IRA, section 401(k), or other tax-qualified defined contribution plan if: (1) the individual has been unemployed for more than 26 weeks by reason of a separation from employment and has received unemployment compensation for that period (or, if less, for the maximum period for which unemployment compensation is available under State law applicable to the individual) (an eligible individual); (2) the distribution is made during the taxable year in which the unemployment compensation is paid or in the succeeding taxable year (which allows for distributions over the same two-year period applicable under current law); and (3) the aggregate of all such distributions does not exceed the annual limits described below.

[Mr.Tako]

If I read that correctly, said distributions could only occur in the same two year period the individual is receiving unemployment insurance.

I don't think that would have a huge impact on the ER community...most of these folks are quitting their jobs, not getting fired.

[Bucksandreds]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

[Vilgan]

While almost all of the changes sound like good things to happen, I'm selfishly hoping they take their time on the S corp changes. 5 years from now sounds like a great time to implement these suggestions :)

[Eric]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

[MayDay]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

PLEASE PLEASE PLEASE.

We are in a position to use a BD Roth, so I am shooting my own self in the foot, but seriously, end the Roth backdoor and just let people put the whole 15K or whatever the 401K limit is into their IRA.  It makes no sense that if you work for an employer who offers a 401K you get to shelter 15K+5K+the match, but if not, you get to shelter 5K. 

NO FUCKING SENSE.

[MayDay]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

It punishes people whose employer does not offer a 401K.   

[Eric]

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

It punishes people whose employer does not offer a 401K.

In what way?

[JLee]

Allowing retroactive 401k contributions for unused contribution space in prior years would be nice...far more usable to me (and most people) than a mega backdoor Roth!

[coppertop]

The rules definitely favor employer-based retirement plans, which annoys me tremendously.  I definitely have to put the $24,000 in a retirement plan because I have no tax deductions and will owe the federal government beaucoup bucks if I don't.  I've learned this the hard way ... but the options in my company's plan are terrible.  I'd much rather be able to put the $24,000 into funds of my own choosing, but the way it is now, I can only put $6,500 in an IRA - and not even that if my income goes over a certain amount of money (I forget, but maybe $110,000?)  Found that out the hard way too.

[seattlecyclone]

The backdoor Roth is a glaring loophole that should be closed. There's no good reason for there to be an income limit that is trivially bypassed. Get rid of the income limit or get rid of the backdoor around it. Pick one.

I say this as someone who has used the regular and "mega" backdoors to stuff my Roth accounts for the past few years. I benefit from the stupid rules with full knowledge that the rules are in fact stupid.

[Bucksandreds]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

Anything that raises taxes on the middle class at a time when the middle class is getting squeezed towards the lower class is definitely a cause for concern. The rich are the richest that they've ever been in the country so tax the hell out of them. The rest of us are worse off than our contemporaries were in years past.

[Vilgan]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

Anything that raises taxes on the middle class at a time when the middle class is getting squeezed towards the lower class is definitely a cause for concern. The rich are the richest that they've ever been in the country so tax the hell out of them. The rest of us are worse off than our contemporaries were in years past.

I don't think people needing to backdoor their Roth are "middle class", at least from the government's perspective. It seems like everyone views themselves as middle class and anyone that makes a good amount more as rich, regardless of how much they make.

[Bucksandreds]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

Anything that raises taxes on the middle class at a time when the middle class is getting squeezed towards the lower class is definitely a cause for concern. The rich are the richest that they've ever been in the country so tax the hell out of them. The rest of us are worse off than our contemporaries were in years past.

I don't think people needing to backdoor their Roth are "middle class", at least from the government's perspective. It seems like everyone views themselves as middle class and anyone that makes a good amount more as rich, regardless of how much they make.

So you wouldn't call $116,000 middle class?  The rich also benefit more from Roth than the middle class as middle class retirees are likely to become lower income in retirement, negating Roth tax advantages. It's a good idea to keep the rich away from the Roth but current Roth limits stop contributions from people who are far from rich, imho.

[JLee]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

Anything that raises taxes on the middle class at a time when the middle class is getting squeezed towards the lower class is definitely a cause for concern. The rich are the richest that they've ever been in the country so tax the hell out of them. The rest of us are worse off than our contemporaries were in years past.

I don't think people needing to backdoor their Roth are "middle class", at least from the government's perspective. It seems like everyone views themselves as middle class and anyone that makes a good amount more as rich, regardless of how much they make.

So you wouldn't call $116,000 middle class?  The rich also benefit more from Roth than the middle class as middle class retirees are likely to become lower income in retirement, negating Roth tax advantages. It's a good idea to keep the rich away from the Roth but current Roth limits stop contributions from people who are far from rich, imho.

$116k MAGI is a lot more than $116k gross, and its certainly upper middle - calling a $130-150k single income "middle class" without any qualifiers is a bit of a stretch. However, there's already been a thread discussing this to death.

I'm more annoyed by losing a tIRA after ~$60k MAGI. :(

[Eric]

It seems like everyone views themselves as middle class and anyone that makes a good amount more as rich, regardless of how much they make.

Yep.  I've been saying it for years.  Everyone, and I mean everyone, thinks of themselves as middle class.  It's pretty hilarious.  A single earner making $150K?  Middle class.  I mean, no matter that it's 3 times the median household income, they feel middle class because [insert excuse here].

It's a wonder how the middle class can contain everyone and also be shrinking at the same time.  Physics and math do not apply to the middle class.

[Cathy]

I still don't understand why so many people seem to think that point-in-time income is the determiner of "class". Back on September 5, 2015, I outlined class definitions that I believe much more accurately reflect what people mean by the class labels. My definitions are also far more useful than the usual "point-in-time" income definitions, which in general convey little to no information about the person's socioeconomic status. Under my superior definitions, a person with a point-in-time income of $150,000 could be middle class.

[Paul der Krake]

As a member of a household that's unlikely to ever burst above the 25% bracket, I selfishly am happy to throw the fat cats high earners under the bus. But please don't take the Roth conversion ladder. That's totally a middle class thing, I swear.

[Eric]

I mean, no matter that it's 3 times the median household income, they feel middle class because [I made up my own definitions of middle class that no one else uses].

Updated for Cathy.  :)

[Cathy]

I mean, no matter that it's 3 times the median household income, they feel middle class because [I made up my own definitions of middle class that no one else uses].

Updated for Cathy.  :)

Although it may be true that "no one" uses my exact definitional scheme, I believe it accurately reflects what people mean when they talk about "class" (at least in the United States and Canada). In general, "class" refers to a rough snapshot of the person's overall station in life relative to the socioeconomic hierarchy. Point-in-time income is largely useless for that purpose (except to the extent described in my definitional post) because point-in-time income is extremely fleeting. My definitions do a much better job of capturing what is meant by the intuitive notion of "class". My definitions are also fully consistent with Mustachian principles insofar as my definitions do not allow somebody to artificially lower her class by being a spendthrift.

Definitions based on point-in-time income are more common in articles that want to make certain political points, but I disagree that those point-in-time income definitions reflect what people intuitively mean by "class".

[Telecaster]

The IRA was created to help lower or middle class people save for retirement.  The $2000 limit that was in place for years and years was set at that amount in order to prevent rich people who don't need the help from stuffing a whole bunch of money in there.  IIRC at one point in time there was in excise tax if the accounts grew too large. 

On a personal level, my wife and I are well above the IRA contribution limit, so the backdoor Roth is a nice benefit for us.  And I'm self-employed and have a SE 401(K), which allows me to stuff a whole more of my income into a retirement account than most folks.  So you can see the backdoor Roth is a good thing for me personally. 

But it is still a bullshit loophole.  It is helping people with a lot of money not pay taxes.  That's not why the IRA was created.   

And yes, lets close the carried interest loophole too, along with a few more total bullshit loopholes.   Then let's lower the tax rates.   That would truly help people not only save, but in their everyday lives.   It will never happen, but a nice thought.   

[Silverado]

The rules definitely favor employer-based retirement plans, which annoys me tremendously.  I definitely have to put the $24,000 in a retirement plan because I have no tax deductions and will owe the federal government beaucoup bucks if I don't.  I've learned this the hard way ... but the options in my company's plan are terrible.  I'd much rather be able to put the $24,000 into funds of my own choosing, but the way it is now, I can only put $6,500 in an IRA - and not even that if my income goes over a certain amount of money (I forget, but maybe $110,000?)  Found that out the hard way too.

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free. Ditto for the reply below this one.

At least Cathy doesn't humblebrag, just plainly states how good her ideas are. That's something.

[Telecaster]

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free.

There's no income limit for  traditional IRA contributions, but traditional IRAs do not grow tax free.  The deduction for an tIRA is capped if you have a retirement plan at work (which the previous poster does). 

[Schaefer Light]

My big concern is that some jackass politician (technically, politicians) will change the Roth IRA withdrawal rules right about the time I need to start withdrawing money from it.

[Bucksandreds]

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

Anything that raises taxes on the middle class at a time when the middle class is getting squeezed towards the lower class is definitely a cause for concern. The rich are the richest that they've ever been in the country so tax the hell out of them. The rest of us are worse off than our contemporaries were in years past.

I don't think people needing to backdoor their Roth are "middle class", at least from the government's perspective. It seems like everyone views themselves as middle class and anyone that makes a good amount more as rich, regardless of how much they make.

So you wouldn't call $116,000 middle class?  The rich also benefit more from Roth than the middle class as middle class retirees are likely to become lower income in retirement, negating Roth tax advantages. It's a good idea to keep the rich away from the Roth but current Roth limits stop contributions from people who are far from rich, imho.

$116k MAGI is a lot more than $116k gross, and its certainly upper middle - calling a $130-150k single income "middle class" without any qualifiers is a bit of a stretch. However, there's already been a thread discussing this to death.

I'm more annoyed by losing a tIRA after ~$60k MAGI. :(

Just out of curiosity. Would you consider me above middle class/upper middle class?  My wife and I and 2 kids earned in the high $100,000s pre tax.  I left school at age 27 with $220,000 in student loans at federally mandated 6.8% interest. (rules just changed to allow refinancing recently) I am 34 and have either been a full time student or worker since childhood with no long break.  Someone who makes just a little more than I would be barred from contributing to a Roth IRA.  At 34 my net worth is barely above $0.  People graduating today with my degree typically leave school with almost $300,000 in student loans in their mid to late 20's.  To me income is not the only consideration for middle class. Wealth, or lack thereof plays a part.

[runningthroughFIRE]

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free.

There's no income limit for  traditional IRA contributions, but traditional IRAs do not grow tax free.  The deduction for an tIRA is capped if you have a retirement plan at work (which the previous poster does).

All IRAs grow tax free; it's their defining feature.  Traditional, Roth, and Nondeductible IRAs differ only in income limits on contributions and whether the money is taxed coming out, going in, or both (respectively).

[JLee]

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free.

There's no income limit for  traditional IRA contributions, but traditional IRAs do not grow tax free.  The deduction for an tIRA is capped if you have a retirement plan at work (which the previous poster does).

All IRAs grow tax free; it's their defining feature.  Traditional, Roth, and Nondeductible IRAs differ only in income limits on contributions and whether the money is taxed coming out, going in, or both (respectively).

What is the advantage of a non-deductible traditional IRA vs a taxable account?

As hard as this would be for many of us, the back door Roth is a tax avoidance system that benefits many very well to do people.  Maybe they should raise the income limit on the regular Roth so as not to punish the middle/upper middle class with this change.

Following the Roth guidelines, as originally intended, would be a punishment?  Interesting perspective...

Anything that raises taxes on the middle class at a time when the middle class is getting squeezed towards the lower class is definitely a cause for concern. The rich are the richest that they've ever been in the country so tax the hell out of them. The rest of us are worse off than our contemporaries were in years past.

I don't think people needing to backdoor their Roth are "middle class", at least from the government's perspective. It seems like everyone views themselves as middle class and anyone that makes a good amount more as rich, regardless of how much they make.

So you wouldn't call $116,000 middle class?  The rich also benefit more from Roth than the middle class as middle class retirees are likely to become lower income in retirement, negating Roth tax advantages. It's a good idea to keep the rich away from the Roth but current Roth limits stop contributions from people who are far from rich, imho.

$116k MAGI is a lot more than $116k gross, and its certainly upper middle - calling a $130-150k single income "middle class" without any qualifiers is a bit of a stretch. However, there's already been a thread discussing this to death.

I'm more annoyed by losing a tIRA after ~$60k MAGI. :(

Just out of curiosity. Would you consider me above middle class/upper middle class?  My wife and I and 2 kids earned in the high $100,000s pre tax.  I left school at age 27 with $220,000 in student loans at federally mandated 6.8% interest. (rules just changed to allow refinancing recently) I am 34 and have either been a full time student or worker since childhood with no long break.  Someone who makes just a little more than I would be barred from contributing to a Roth IRA.  At 34 my net worth is barely above $0.  People graduating today with my degree typically leave school with almost $300,000 in student loans in their mid to late 20's.  To me income is not the only consideration for middle class. Wealth, or lack thereof plays a part.

I think that's a slight exaggeration. Phase out starts at $184k married filing jointly, then factor in your $12,600 standard deduction, $16,000 in exemptions, and two 401k's and your phase-out limit is $248,600 before HSA and any other deductions you may have. The difference between high $100,000's and ~$250k is the median household income in the United States.

[Tabaxus]

The problem with defining class in terms of wealth is that it basically gives high spenders a cop-out to whine about the fact that they're only middle class because "oh I just have so many expenses"

Guess what?  People who only make $20-30k live in the same cities as you do, have kids, have to buy food, have to pay for all of the essentials of life.  They are poor.  People who make 40-80k or whatever also live in the same cities as you do and have all of the same expenses.  They are middle class. You make over $100k, don't care if it's a HCOL area.  You elected an expense--living in a high COL area.  Whatever your reasoning, including high income jobs available in that area, you're still upper class at an income level that is multiples of the average annual household income.  You may elect other expenses, like the fact that your precious little darling couldn't possibly go [to the same inner-city schools that poor and middle class people go to], or you absolutely must have precious little darlings at all (and more than one, even!), or you couldn't possibly live with [the commute that poor and middle class people have in HCOL areas.]  Those are all elective expenses.  There's nothing wrong with your decision to elect those expenses in lieu of building wealth, but you don't get to cop out of the fact that you're upper class because of it.  Embrace it, for f's sake.

When I came out of law school with ~$200k in debt making ~$170k out of the box, I recognized that I was rich, despite the HCOL and the fact that I don't remotely spend like I'm rich.  Why?  Because I've been able to wipe out debt that it would take an actual poor/middle class person much longer to wipe out.  I've been able to save a lot more money that an actual poor/middle class person could save.  Sure, I am richer than someone who is just making $100k, and I've also elected to defer certain expenses like buying a house and having kids until I'm on firmer financial footing--but none of that means I'm not rich.

ETA:  Getting back to the original thread.  Backdoor Roth IRA is an obvious tax avoidance scheme.  It shocks me that the IRS didn't clamp down on it as soon as it started--it would be very easy for them to do so.  Getting rid of it makes eminent sense.  Make an affirmative policy choice to allow contributions, or not, but don't create a tax hole that anyone with a Vanguard account can abuse.

[runningthroughFIRE]

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free.

There's no income limit for  traditional IRA contributions, but traditional IRAs do not grow tax free.  The deduction for an tIRA is capped if you have a retirement plan at work (which the previous poster does).

All IRAs grow tax free; it's their defining feature.  Traditional, Roth, and Nondeductible IRAs differ only in income limits on contributions and whether the money is taxed coming out, going in, or both (respectively).

What is the advantage of a non-deductible traditional IRA vs a taxable account?

A Nondeductible account's interest and dividends grow tax free until you withdraw them.  In a taxable account, you are taxed on the income you earn to invest (e.g. $100 in a 25% bracket means you have $75 to invest), then any dividends or recognized capital gains (such as from asset reallocations) are taxed when distributed/reallocated, and then you get taxed on capital gains whenever you withdraw anything that has gone up in value.

A nondeductibe account removes that middle piece of tax ondividends and capital gains from asset reallocations.  The Nondeductible IRA is strictly worse than Traditional and Roth, but still better than taxable accounts if you don't mind the restrictions such as the early withdrawl penalty.

[Tabaxus]

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free.

There's no income limit for  traditional IRA contributions, but traditional IRAs do not grow tax free.  The deduction for an tIRA is capped if you have a retirement plan at work (which the previous poster does).

All IRAs grow tax free; it's their defining feature.  Traditional, Roth, and Nondeductible IRAs differ only in income limits on contributions and whether the money is taxed coming out, going in, or both (respectively).

What is the advantage of a non-deductible traditional IRA vs a taxable account?

A Nondeductible account's interest and dividends grow tax free until you withdraw them.  In a taxable account, you are taxed on the income you earn to invest (e.g. $100 in a 25% bracket means you have $75 to invest), then any dividends or recognized capital gains (such as from asset reallocations) are taxed when distributed/reallocated, and then you get taxed on capital gains whenever you withdraw anything that has gone up in value.

A nondeductibe account removes that middle piece of tax ondividends and capital gains from asset reallocations.  The Nondeductible IRA is strictly worse than Traditional and Roth, but still better than taxable accounts if you don't mind the restrictions such as the early withdrawl penalty.

Putting money in a nondeductible traditional can convert capital gains into ordinary income.  I don't think it's a superior vehicle to taxable accounts, particularly because if yo're at the point of making contributions to a nondeductible IRA, you probably have maxed out other deferred tax space in such a way that your required distributions are, in fact, going to have you paying at least some tax.

[bacchi]

PLEASE PLEASE PLEASE.

We are in a position to use a BD Roth, so I am shooting my own self in the foot, but seriously, end the Roth backdoor and just let people put the whole 15K or whatever the 401K limit is into their IRA.  It makes no sense that if you work for an employer who offers a 401K you get to shelter 15K+5K+the match, but if not, you get to shelter 5K. 

NO FUCKING SENSE.

Exactly. This goes for health insurance premiums, too.

[Cathy]

The problem with defining class in terms of wealth is that it basically gives high spenders a cop-out to whine about the fact that they're only middle class because "oh I just have so many expenses" ...

As mentioned, my definitions avoid this problem.

When I came out of law school with ~$200k in debt making ~$170k out of the box, I recognized that I was rich, ...

You weren't rich. You may have had a decent chance of becoming rich in the future, but that was by no means guaranteed. You could have turned out to be terrible at the practice of law and been fired in less than a year. You might have struggled to find another job. More remotely, there could have been major structural changes in the practice of law, perhaps increasing the range of services that can be legally provided by people who are not licensed to practice law as has happened in Ontario and England. Any of a number of things could have radically reduced your future earning potential at that point. Sure, you would have adapted, but my point is, the future was not certain at that point. If you aren't persuaded by my examples of uncertainties, come up with your own; there is no shortage of them as the future is unknown. You may have had a reasonable chance of becoming rich, but that was all you had. Saying you were already rich at that point is putting the cart before the horse.

My definitions handle all of this.

[Scubanewbie]

PLEASE PLEASE PLEASE.

We are in a position to use a BD Roth, so I am shooting my own self in the foot, but seriously, end the Roth backdoor and just let people put the whole 15K or whatever the 401K limit is into their IRA.  It makes no sense that if you work for an employer who offers a 401K you get to shelter 15K+5K+the match, but if not, you get to shelter 5K. 

NO FUCKING SENSE.

Exactly. This goes for health insurance premiums, too.

+1

[spud1987]

The backdoor Roth is a glaring loophole that should be closed. There's no good reason for there to be an income limit that is trivially bypassed. Get rid of the income limit or get rid of the backdoor around it. Pick one.

I say this as someone who has used the regular and "mega" backdoors to stuff my Roth accounts for the past few years. I benefit from the stupid rules with full knowledge that the rules are in fact stupid.

I agree that the loophole makes no sense if you believe that a Roth should have income limits. The mega backdoor Roth makes even less sense and I don't know why the IRS permitted the strategy in 2014. That being said, like you, I am taking advantage of the loopholes since they are perfectly legal. I have been able to stuff my Roth with an additional 25k/year.

I doubt Congress cares much about the loophole though because it has very little present day revenue impact (because you are paying taxes on Roth contributions today). However, the loophole will have a significant revenue impact in the future when retirees start withdrawing from mega Roths and no taxes are paid. I'm not sure Congress cares much about revenue impacts in 20+ years though, especially since all bills only look out 10 years for revenue projections.

[runningthroughFIRE]

I don't understand the bold part. I have never seen an income limit for an IRA. I assume you mean being able to deduct it? Don't let not being able to deduct it from your taxes keep you from maxing it out. Still grows tax free.

There's no income limit for  traditional IRA contributions, but traditional IRAs do not grow tax free.  The deduction for an tIRA is capped if you have a retirement plan at work (which the previous poster does).

All IRAs grow tax free; it's their defining feature.  Traditional, Roth, and Nondeductible IRAs differ only in income limits on contributions and whether the money is taxed coming out, going in, or both (respectively).

What is the advantage of a non-deductible traditional IRA vs a taxable account?

A Nondeductible account's interest and dividends grow tax free until you withdraw them.  In a taxable account, you are taxed on the income you earn to invest (e.g. $100 in a 25% bracket means you have $75 to invest), then any dividends or recognized capital gains (such as from asset reallocations) are taxed when distributed/reallocated, and then you get taxed on capital gains whenever you withdraw anything that has gone up in value.

A nondeductibe account removes that middle piece of tax ondividends and capital gains from asset reallocations.  The Nondeductible IRA is strictly worse than Traditional and Roth, but still better than taxable accounts if you don't mind the restrictions such as the early withdrawl penalty.

Putting money in a nondeductible traditional can convert capital gains into ordinary income.  I don't think it's a superior vehicle to taxable accounts, particularly because if yo're at the point of making contributions to a nondeductible IRA, you probably have maxed out other deferred tax space in such a way that your required distributions are, in fact, going to have you paying at least some tax.

Sure it converts your capital gains to ordinary income, but it also defers the tax for potentially decades.  I'm unconvinced by the taxable required distribution argument, because you'd be paying those taxes at some point anyways and by deferring the tax on growth you would have a higher net amount after taxes, even though you are paying more in total taxes.

As with most tax planning decisions, there's bound to be cases where the taxable account ends up better, but any tax advantaged account should be better in the general case.  If not, then the nontaxable option wouldn't exist.

[seattlecyclone]

Converting capital gains into ordinary income can be a pretty big deal, especially given the current tax brackets. If you plan to retire in the 15% bracket, you might not owe tax on dividends or capital gains at all.

[Tabaxus]

Converting capital gains into ordinary income can be a pretty big deal, especially given the current tax brackets. If you plan to retire in the 15% bracket, you might not owe tax on dividends or capital gains at all.

Plus, the majority of growth in long-term investing, unless you're dividend-focused (or in bonds) comes from appreciation in shares, which, like a traditional IRA, is tax-deferred.  I struggle very much with the concept that non-deductible traditional IRA is ever worth it (under current tax law) for people who are heavily invested in a broad index of stocks.

[Monkey Uncle]

Everyone seems to be stuck on the proposal to eliminate the backdoor roth, but this is the proposal that scares the shit out of me:

Introduce Required Minimum Distribution (RMD) Obligations For Roth IRAs

Potentially a "yuge" lifetime tax increase for those of us who are planning to use a Roth pipeline.

[Eric]

Everyone seems to be stuck on the proposal to eliminate the backdoor roth, but this is the proposal that scares the shit out of me:

Introduce Required Minimum Distribution (RMD) Obligations For Roth IRAs

Potentially a "yuge" lifetime tax increase for those of us who are planning to use a Roth pipeline.

Distributions from Roth IRAs are tax free.  That's the whole point of having money in a Roth!

[seattlecyclone]

Roth IRA RMDs would increase your taxes to the extent that you're forced to move Roth assets into a taxable account where they would then be subject to dividend and capital gains taxes. The main point of this is to try and encourage people to spend down their Roth IRA during their lifetime so that their kids (or grandkids) won't inherit an account that grows tax-free for a few decades after the original owner's death.

[Think]

My big concern is that some jackass politician (technically, politicians) will change the Roth IRA withdrawal rules right about the time I need to start withdrawing money from it.

This is a concern.  I was surprised reading previous mmm that indicate many don't worry at all about taxes.  Fire is absolutely dependent on taxes.  Changes in the tax code could have you going back to work. 

[Telecaster]

This is a concern.  I was surprised reading previous mmm that indicate many don't worry at all about taxes.  Fire is absolutely dependent on taxes.  Changes in the tax code could have you going back to work.

Future tax rates beyond the control of all of us.   There are number of things FIRE is absolutely dependent on that we have no control over.   Future investment returns, for example.  But the only way to eliminate all risk is to never FIRE.   At some point you just have to accept the risk and pull the pin.   

[Monkey Uncle]

Roth IRA RMDs would increase your taxes to the extent that you're forced to move Roth assets into a taxable account where they would then be subject to dividend and capital gains taxes. The main point of this is to try and encourage people to spend down their Roth IRA during their lifetime so that their kids (or grandkids) won't inherit an account that grows tax-free for a few decades after the original owner's death.

Bingo.  I could envision a scenario wherein the RMDs outpace spending such that your taxable account is throwing off enough dividends and cap gains (especially in combination with SS/pension income) to push you beyond the 15% tax bracket.  At which point your qualified dividends and capital gains would no longer be taxed at 0%.  The extra taxable income also contributes to your total income, which means your SS benefits could become taxable or be taxed at a higher rate than they otherwise would have.

[Monkey Uncle]

This is a concern.  I was surprised reading previous mmm that indicate many don't worry at all about taxes.  Fire is absolutely dependent on taxes.  Changes in the tax code could have you going back to work.

Future tax rates beyond the control of all of us.   There are number of things FIRE is absolutely dependent on that we have no control over.   Future investment returns, for example.  But the only way to eliminate all risk is to never FIRE.   At some point you just have to accept the risk and pull the pin.

True, but it would seem to be unwise to plan FIRE such that it depends on the continued existence of a particular tax shelter (like the Roth pipeline).

[Paul der Krake]

This is a concern.  I was surprised reading previous mmm that indicate many don't worry at all about taxes.  Fire is absolutely dependent on taxes.  Changes in the tax code could have you going back to work.

Future tax rates beyond the control of all of us.   There are number of things FIRE is absolutely dependent on that we have no control over.   Future investment returns, for example.  But the only way to eliminate all risk is to never FIRE.   At some point you just have to accept the risk and pull the pin.

True, but it would seem to be unwise to plan FIRE such that it depends on the continued existence of a particular tax shelter (like the Roth pipeline).

That depends how early one retires, or rather one's ability to adapt. I can totally see how a change in the tax code screwing someone who retires at 55 from a job with few open positions, as opposed to a younger early retiree with in-demand chops retiring at 35.

[runningthroughFIRE]

Converting capital gains into ordinary income can be a pretty big deal, especially given the current tax brackets. If you plan to retire in the 15% bracket, you might not owe tax on dividends or capital gains at all.

Plus, the majority of growth in long-term investing, unless you're dividend-focused (or in bonds) comes from appreciation in shares, which, like a traditional IRA, is tax-deferred.  I struggle very much with the concept that non-deductible traditional IRA is ever worth it (under current tax law) for people who are heavily invested in a broad index of stocks.

I agree that converting capital gains to ordinary income is a big deal. My thinking was that if I were investing through a nondeductible IRA, I would be eventually piping it to a Roth just as I plan to do with my Traditional accounts, and my income should be low enough at that point that the taxes paid on the account are minimal to nonexistent (my personal situation bias here).  I haven't seen many cases where someone's only option is the nondeductible account vs taxable investing, so I can't offer examples where one would be better than the other, but I'm finding it hard to believe that one always trumps the other in either direction.

[seattlecyclone]

Converting capital gains into ordinary income can be a pretty big deal, especially given the current tax brackets. If you plan to retire in the 15% bracket, you might not owe tax on dividends or capital gains at all.

Plus, the majority of growth in long-term investing, unless you're dividend-focused (or in bonds) comes from appreciation in shares, which, like a traditional IRA, is tax-deferred.  I struggle very much with the concept that non-deductible traditional IRA is ever worth it (under current tax law) for people who are heavily invested in a broad index of stocks.

I agree that converting capital gains to ordinary income is a big deal. My thinking was that if I were investing through a nondeductible IRA, I would be eventually piping it to a Roth just as I plan to do with my Traditional accounts, and my income should be low enough at that point that the taxes paid on the account are minimal to nonexistent (my personal situation bias here).  I haven't seen many cases where someone's only option is the nondeductible account vs taxable investing, so I can't offer examples where one would be better than the other, but I'm finding it hard to believe that one always trumps the other in either direction.

The choice between a non-deductible traditional IRA vs. taxable account is a "problem" only faced by people over the Roth IRA contribution limit ($117k MAGI for singles, $189k MAGI for married couples).

Let's consider a working Mustachian in this income range, planning to retire in the 15% bracket. Assume no changes in the tax code.

If they go with a taxable account, invest in VTSAX, and don't sell until retirement, they'll pay 15% dividend tax on the 2% dividend yield every year until retirement. After retirement, dividends and capital gains would be tax-free.

If they go with a non-deductible IRA, no tax is due on dividends while they're working, but they'll pay 15% on these dividends and all of their capital gains when they withdraw from the account or convert it to Roth.

I have a hard time seeing how the non-deductible IRA could win out, except possibly if Bernie Sanders' idea to tax investment income the same as other income gets passed.

[runningthroughFIRE]

Deductions, exemptions, and credits can bring tax due down to zero even for ordinary income.  The Roth pipeline can be started after retirement for someone highly risk averse who stockpiles enough cash reserves to last through the 5 years.  I've seen enough weird tax scenarios to know that there will be some combination of factors leading to the nondeductible account being more advantageous.

[Think]

This is a concern.  I was surprised reading previous mmm that indicate many don't worry at all about taxes.  Fire is absolutely dependent on taxes.  Changes in the tax code could have you going back to work.

Future tax rates beyond the control of all of us.   There are number of things FIRE is absolutely dependent on that we have no control over.   Future investment returns, for example.  But the only way to eliminate all risk is to never FIRE.   At some point you just have to accept the risk and pull the pin.

Right but tax rates are a huge driver.  consider a scenario where a 401k, Roth and investment income are no longer tax advantaged.  Oh and w2 income tax rates increase.  And no mortgage deduction.

[seattlecyclone]

That perfect storm of tax increases seems so unlikely that I tend not to worry about it much, and I certainly won't lengthen my working career out of fear that it will happen. Even if it does happen, such a massive increase in taxation will likely come along with an increase in social services, which might mean that your necessary non-tax expenses would be going down even as your taxes went up.