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double taxation on traditional IRAs
Topic Started: Apr 7 2010, 06:05 PM (2,390 Views)
Horace
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HOLY CARP!!!
I'm not sure if I'm reading the rules right but it seems like contributions to traditional IRAs are with after-tax money (if you make more than some low income threshold), and the money is taxed again as income upon withdrawal. The only advantage is to defer income taxes on any cap gains. It's pretty wrong that they don't allow you to deduct IRA contributions. And it makes no sense for older people to aggressively pursue "catchup contributions" since they have less time to overcome the double taxation with cap gains.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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kathyk
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You're not reading the rules correctly. Traditional IRAs are only funded with pre-tax $$. You can only fund them with up to 5K or 6K per year (depending on your age), and only if your income is below a certain threshold. ROTH IRAs are the ones that you put after-tax $$ into, and the benefit is that you don't pay taxes on the income that accrues in them.
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Red Rice
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kathyk
Apr 7 2010, 06:32 PM
You're not reading the rules correctly. Traditional IRAs are only funded with pre-tax $$. You can only fund them with up to 5K or 6K per year (depending on your age), and only if your income is below a certain threshold. ROTH IRAs are the ones that you put after-tax $$ into, and the benefit is that you don't pay taxes on the income that accrues in them.
No, Horace is right. Beyond a certain income level you can still contribute to a traditional IRA, but you can only do so with after-tax dollars.
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John Galt
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+1

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Horace
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Thanks all.

The other qualifier appears to be whether you are covered by an employer retirement plan like a 401k. If you are, and you make more than like 65k for a single head of household, then traditional IRA contributions are indeed taxed as income twice, since they're not deductible and they're taxed again upon IRA withdrawal.

Probably still makes sense to contribute if you're not planning on withdrawing for a couple decades.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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kathyk
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Red Rice
Apr 7 2010, 06:38 PM
kathyk
Apr 7 2010, 06:32 PM
You're not reading the rules correctly. Traditional IRAs are only funded with pre-tax $$. You can only fund them with up to 5K or 6K per year (depending on your age), and only if your income is below a certain threshold. ROTH IRAs are the ones that you put after-tax $$ into, and the benefit is that you don't pay taxes on the income that accrues in them.
No, Horace is right. Beyond a certain income level you can still contribute to a traditional IRA, but you can only do so with after-tax dollars.
Really? That's news to me. That begs the question then, what benefit would there be in making contributions to one if they're not with tax-deferred income?

So, in response to Horace's comment about the unfairness, I'd say that Congress decided that people with incomes above a certain level shouldn't be given the tax benefit of deferring income on IRAs. That makes sense to me, but then so does a progressive tax system.
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kathyk
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Horace
Apr 7 2010, 06:49 PM
Thanks all.

The other qualifier appears to be whether you are covered by an employer retirement plan like a 401k. If you are, and you make more than like 65k for a single head of household, then traditional IRA contributions are indeed taxed as income twice, since they're not deductible and they're taxed again upon IRA withdrawal.

Probably still makes sense to contribute if you're not planning on withdrawing for a couple decades.
Why wouldn't you just contribute to a ROTH if you don't get the tax-deferred benefit?
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CHAS
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Yes, at some point of income a Roth is much better
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Horace
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kathyk
Apr 7 2010, 07:07 PM
Red Rice
Apr 7 2010, 06:38 PM
kathyk
Apr 7 2010, 06:32 PM
You're not reading the rules correctly. Traditional IRAs are only funded with pre-tax $$. You can only fund them with up to 5K or 6K per year (depending on your age), and only if your income is below a certain threshold. ROTH IRAs are the ones that you put after-tax $$ into, and the benefit is that you don't pay taxes on the income that accrues in them.
No, Horace is right. Beyond a certain income level you can still contribute to a traditional IRA, but you can only do so with after-tax dollars.
Really? That's news to me. That begs the question then, what benefit would there be in making contributions to one if they're not with tax-deferred income?
the benefit is that the IRA is tax deferred with respect to cap gains. For someone who wants to buy and sell stocks without regard to capital gains tax implications, being able to do so in an IRA account can be attractive. You just have to convince yourself that the tax-deferred capital gains over time will overcome the loss of the original capital due to the double taxation.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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Horace
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HOLY CARP!!!
kathyk
Apr 7 2010, 07:08 PM
Horace
Apr 7 2010, 06:49 PM
Thanks all.

The other qualifier appears to be whether you are covered by an employer retirement plan like a 401k. If you are, and you make more than like 65k for a single head of household, then traditional IRA contributions are indeed taxed as income twice, since they're not deductible and they're taxed again upon IRA withdrawal.

Probably still makes sense to contribute if you're not planning on withdrawing for a couple decades.
Why wouldn't you just contribute to a ROTH if you don't get the tax-deferred benefit?
I would, but there are restrictions regarding Roth eligibility that I don't meet.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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jon-nyc
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Cheers
kathyk
Apr 7 2010, 07:08 PM
Horace
Apr 7 2010, 06:49 PM
Thanks all.

The other qualifier appears to be whether you are covered by an employer retirement plan like a 401k. If you are, and you make more than like 65k for a single head of household, then traditional IRA contributions are indeed taxed as income twice, since they're not deductible and they're taxed again upon IRA withdrawal.

Probably still makes sense to contribute if you're not planning on withdrawing for a couple decades.
Why wouldn't you just contribute to a ROTH if you don't get the tax-deferred benefit?
Because roth's are only available to people below a certain income level.


In my defense, I was left unsupervised.
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jon-nyc
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Horace
Apr 7 2010, 06:05 PM
I'm not sure if I'm reading the rules right but it seems like contributions to traditional IRAs are with after-tax money (if you make more than some low income threshold), and the money is taxed again as income upon withdrawal.
You don't pay taxes again on the amount you contributed, just the gain.


If you do the math, you'll find that it doesn't make sense to buy stocks in a traditional IRA (at least not under current tax law). I still max out our traditional IRAs every year and use them for fixed income investments.
In my defense, I was left unsupervised.
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Horace
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HOLY CARP!!!
jon-nyc
Apr 8 2010, 02:49 AM
Horace
Apr 7 2010, 06:05 PM
I'm not sure if I'm reading the rules right but it seems like contributions to traditional IRAs are with after-tax money (if you make more than some low income threshold), and the money is taxed again as income upon withdrawal.
You don't pay taxes again on the amount you contributed, just the gain.
Ah, that makes sense, thanks.

Quote:
 
If you do the math, you'll find that it doesn't make sense to buy stocks in a traditional IRA (at least not under current tax law).


I'm not sure what you mean here, can you elaborate? I buy stocks in my rollover IRA (401k from a previous employer) regularly and there are no tax implications other than eventual withdrawals being taxed as income.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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jon-nyc
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Right. Lets say you have 1000 in your taxable acct, and 1000 in your TIRA. You buy 1k worth of the same stock in each.

20 years later, you're retired and you've got (say) 5k in each account. You sell the 5k in your taxable and pay 15% cap gains, which is $600 (4k gain *15%). You net 4400. You take a distribution from your TIRA and pay income tax on the 4k gain, say you're in the 25% bracket so that's 1k. Hence you net 4k. (can be worse disparity if you're in the 30 or 33% bracket)


Of course tax laws can and will change, but as long as there's an advantage to cap gains over ordinary income (which seems reasonably likely to persist over time) then you lose out buying sticks in a traditional IRA.

Instead, use your TIRA for investments that are taxed as ordinary income like bonds. Personally I use my TIRA for REITS and TIPS.


(i should point out that the above calculation is simplified - it assumed no dividends or taxable distribution you might get if you owned an equity mutual fund instead of plain equities - still under most scenarios you'll find you're better off holding equity positions in taxable account or in a ROTH, and fixed income in a traditional IRA.
In my defense, I was left unsupervised.
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Axtremus
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Jon's math works when you hold stocks long enough to qualify for long term cap. gains. ;)

Also, the initial condition is not equal. Starting with $1000 in TIRA means first having $1000, but starting with $1000 in taxable account means first having $1000 * (1 + your marginal tax rate). The difference is later compounded.
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jon-nyc
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That's only true if you're below a certain income level. Given the question he asked, I assume Horace can't take the deduction for the TIRA contribution. So the initial conditions are the same.


Even if they aren't, I still wouldn't advise buying the equity in the TIRA. I'd say yes, contribute to the TIRA, but use it for fixed income investments.
In my defense, I was left unsupervised.
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Horace
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jon-nyc
 
Right. Lets say you have 1000 in your taxable acct, and 1000 in your TIRA. You buy 1k worth of the same stock in each.
20 years later, you're retired and you've got (say) 5k in each account. You sell the 5k in your taxable and pay 15% cap gains, which is $600 (4k gain *15%). You net 4400. You take a distribution from your TIRA and pay income tax on the 4k gain, say you're in the 25% bracket so that's 1k. Hence you net 4k. (can be worse disparity if you're in the 30 or 33% bracket)

Of course tax laws can and will change, but as long as there's an advantage to cap gains over ordinary income (which seems reasonably likely to persist over time) then you lose out buying sticks in a traditional IRA.
Instead, use your TIRA for investments that are taxed as ordinary income like bonds. Personally I use my TIRA for REITS and TIPS.

(i should point out that the above calculation is simplified - it assumed no dividends or taxable distribution you might get if you owned an equity mutual fund instead of plain equities - still under most scenarios you'll find you're better off holding equity positions in taxable account or in a ROTH, and fixed income in a traditional IRA.

 
I see what you're saying Jon, thanks.  I think you're coming at it from the perspective of wanting those REITS or TIPS as part of your portfolio in any case and looking for the best account to hold them in.  I agree a traditional ira is a good choice for that.
 
But, generalizing from there to "it's not a good idea to buy stocks in a traditional IRA" is a stretch for several reasons.  The most important is probably that when one sells a stock in a TIRA, no taxes have to be paid at that time and 100% of the cap gains can be re-invested.  In a taxed investment account, I'd pay 25% on long term cap gains (CA taxes all cap gains as regular income, i.e. 10%) and more on short term, leaving less to re-invest.
 
I don't suppose I'll be in an especially high tax bracket when I take distributions from the TIRA, so the long term cap gains tax rate will probably not be substantially lower than the income taxes I pay on the distributions.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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jon-nyc
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True, if you're going to do a lot of day trading, you're better off doing it in a TIRA.
In my defense, I was left unsupervised.
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jon-nyc
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Where are you putting your fixed income allocation then?
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Horace
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I have a stable income fund in my 401k. I have only a small percentage of my savings in taxable accounts, and that will be even more true if/when I buy a home.
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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Mark
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The income tax is foul.
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Horace
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Regarding day trading, I don't think one would need to be that active in order for trading from a tira to make sense. Even for a buy and hold approach, one is likely to have several hundred transactions over the life of the tira, and not having to pay taxes at the time of those transactions and not having to even consider whether one has held a stock for a year or not is pretty nice.

(and the best part, no tax paperwork forcing you to track every transaction.)
As a good person, I implore you to do as I, a good person, do. Be good. Do NOT be bad. If you see bad, end bad. End it in yourself, and end it in others. By any means necessary, the good must conquer the bad. Good people know this. Do you know this? Are you good?
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jon-nyc
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I wouldn't think so. I'm a buy and hold guy, and I almost never sell anything. Maybe once or twice in the last 5 years when some asset class gets too out of whack - like Gold or China, something real volatile.


Other than that I just buy.


But still, your point is valid. If you churn the account enough, my advice no longer holds.
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Kincaid
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Someone that knows please just tell me where to put my money.
Kincaid - disgusted Republican Partisan since 2006.
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jon-nyc
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Check your PM, Kincaid. You'll find an account number you can wire it to. :lol:
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