Contribute to Roth or Tradition IRA?

[letmeride]

Entering last year, I was no longer able to directly contribute to Roth IRA due to making over 132k as a single. So, I was advised to make nondeductible contribution to my traditional IRA and then convert to Roth IRA. Going into 2017, should I continue this method or just leave in traditional IRA? Or do I want both my Traditional and Roth IRA to grow somewhat balanced so maybe alternate every other year? I plan to put the max contribution in beginning of Jan 2017.

[MakeAStash]

If all your tIRA dollars are non-deductible, convert them to Roth soon because the tax upon that conversion will be only on earnings, typically small if little time has elapsed since the tIRA contrib. If you also have deductible tIRA contribs, perhaps from the past, the conversions to Roth are prorated to include those, which means more tax will be due, possibly enough that converting to Roth would not be a good idea.

If you are not soon converting them to Roth, non-deductible contribs to tIRA are not a good idea. You'll likely have more after-tax money later by instead simply investing those dollars outside an IRA. Why? Because capital gains outside an IRA are taxed at a preferred lower rate, even 0% if your income is low enough, whereas those same capital gains made within a tIRA will be upon withdrawal taxed at ordinary rates, which are some of the highest going. That is called The IRA Trap. Of course tax rates and structure may change in the future.

[letmeride]

If all your tIRA dollars are non-deductible, convert them to Roth soon because the tax upon that conversion will be only on earnings, typically small if little time has elapsed since the tIRA contrib. If you also have deductible tIRA contribs, perhaps from the past, the conversions to Roth are prorated to include those, which means more tax will be due, possibly enough that converting to Roth would not be a good idea.

If you are not soon converting them to Roth, non-deductible contribs to tIRA are not a good idea. You'll likely have more after-tax money later by instead simply investing those dollars outside an IRA. Why? Because capital gains outside an IRA are taxed at a preferred lower rate, even 0% if your income is low enough, whereas those same capital gains made within a tIRA will be upon withdrawal taxed at ordinary rates, which are some of the highest going. That is called The IRA Trap. Of course tax rates and structure may change in the future.

The conversion happened immediately. However, you dont address if I should continue this method in the future or just leave in tIRA to grow?

[feh]

If all your tIRA dollars are non-deductible, convert them to Roth soon because the tax upon that conversion will be only on earnings, typically small if little time has elapsed since the tIRA contrib. If you also have deductible tIRA contribs, perhaps from the past, the conversions to Roth are prorated to include those, which means more tax will be due, possibly enough that converting to Roth would not be a good idea.

This is an important point to consider, and one that I think most people are not aware of. This is what keeps us from following the conversion strategy, as we have quite a bit of what were deductible contributions in our traditional IRAs.

[Petunia 100]

The conversion happened immediately. However, you dont address if I should continue this method in the future or just leave in tIRA to grow?

There is no advantage to leaving non-deductible contributions sitting in a traditional IRA. Sometimes you might choose not to convert because it is a taxable event (due to existing deductible contributions in a traditional, SEP, or Simple IRA). But if it is not, it's a no-brainer. Convert.

Are you contributing to an employer plan? If not, you should be.

[clatoden99]

There is no provision that I know of to withdraw tax-free when leaving the country, so you should keep the withdrawal penalty in mind.

Note that if your home country has a tax treaty with the US, the penalty might offset taxes you pay at home, so it would be effectively negated.

Some countries like Canada recognize the Roth IRA as a post-tax savings vehicle (similar to a pension) and do not tax it. In that case you'd get the same benefit from a Roth IRA as an USer would.

For a 401k-type plan for which your employer offers a significant match, the match might dwarf the penalty, thus making it worth your while to contribute to the plan but regularly withdraw.

There is an exception to the penalty for education withdrawals, but if you're planning to make the withdrawal in the near future I would question whether the hassle outweighs the benefits. 529 plans are a more effective savings vehicle for higher education and have fewer restrictions.

Generally, though, IRAs won't be useful to you if you don't plan to reside in the US long term.

This should not be construed as tax advice and you should contact a professional to discuss your individual situation.