no match 401k vs Non-deductible IRA
All things being equal, would it be more advantageous for a 35 year old client in a 35% effective tax bracket to contribute $5,000 to his no match employer 401k with pre-tax contributions hence, fully taxable distributions or to a non-deductible IRA with gains taxable only? Reading through Pub 590 only confused me more. Is there a calculator on this great site that could analyze this for me? Thanks for any help you can give!
Permalink Submitted by Alan Spross on Wed, 2009-05-13 20:57
If his federal marginal rate is now 35%. it is slated to go to 39.6% under Obama’s tax plan effective in 2011. If he does not have IRA assets at present, he should make the non deductible contribution and file Form 8606. In January he can convert this IRA tax free to a Roth IRA except for the earnings that accrue between the contribution and the conversion. However, if he already has TIRA accounts, the pre tax balances would render most of this conversion taxable.
If the current 35% bracket is a one year event and his income will reduce in the future, then the pre tax 401k contribution could be best. Many 401k plans now have a Roth option, so he may be able to just make his contribution to the Roth option of his 401k if it is offered.
Most 35 year olds already in the top bracket will remain there in the future and therefore should be trying to get some assets into a Roth 401k or Roth IRA option to hedge against future tax increases, and 39.6 might only be the start after 2011. But without knowing much more about his current retirement assets, there could be other variables that affect this decision.
Permalink Submitted by David Toth on Thu, 2009-05-14 11:55
Thanks for your reply alan-oniras!
That was my thought to convert to Roth. No Roth 401k option at work. Client currently has Roth assets as well as other TIRA assets from both past contributions and rollovers. How does that affect the conversion of his non-dedcutible TIRA? Tax bracket will continue to be the same or increase and his AGI puts him over the Roth contribution phaseout limit.
Permalink Submitted by Alan Spross on Thu, 2009-05-14 17:28
Under these circumstances, the chance of qualifying to make regular Roth contributions is slim. With no Roth 401k option, conversions starting next year when the income limit disappears will likely be his only source of Roth assets. The existence of other TIRA accounts that are presumably heavily weighted with pre tax funds because of the rollovers means that any conversion from any of his IRA accounts will be mostly taxable. While he can convert the account holding non deductible contributions, the balance in all of his TIRA accounts must be considered in determining the taxable % of the conversion. These calculations are all done in Parts I and II of Form 8606. Only after his TIRAs are entirely converted could he make a non deductible TIRA contribution and convert it totally tax free.