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Should you make a non-deductible IRA contribution?
A quick Google search will make you think you should.
I vehemently disagree.
Financial Complexity, that evil villain, is always trying to misguide you. He loves “technically” correct answers because they usually blow up in your face.
If you make more than $204,000, the only way to put money into your IRA is a non-deductible contribution. “Non-deductible”, meaning money you’ve already paid taxes on.
If you do, then you’ll only pay taxes on the gains. And that’s not until you withdraw it for vacations and groceries in retirement.
That’s why Google likes it – tax-deferred growth.
While tax-deferred growth is a good thing, it blows up in practice for two reasons. One we’ll look at this week, one we’ll save for next week.
When you take that money out in retirement, you’ll need to know how much money you put in. Because that’s the money you shouldn’t pay taxes on again.
But here’s the catch…
Your brokerage company won’t track it for you. Neither will the IRS.
It’s up to you to save 20-30 years worth of Form 5498 – the IRS form that shows how much you contributed.
What are the chances you’ll keep up with that?
The more likely scenario is you’ll lose track and end up paying taxes on the gains (as you should) and then pay taxes on your contributions AGAIN.
Put the money you would use for a non-deductible IRA contribution into your brokerage account instead.
Sure, you won’t defer taxes and have to pay up on capital gains and dividends along the way. But if you’re invested in a long-term, buy-and-hold, low-cost ETF portfolio, the taxes will be next to nothing anyway.
More importantly, you’ll ensure you won’t unwittingly donate extra money to Uncle Sam by paying taxes twice on the same money.