The Tax Benefits of an IRA

The non-deductible IRA would be better for investments that would produce lots of annual taxes in a taxable account, since the taxes would be deferred in the IRA. This includes many actively managed mutual funds that have large asset turnover, which tends to produce big year-end distributions.

It also includes bonds and bond funds with lots of interest earnings. Interest is taxed as income in both the taxable account and the IRA, but the tax can be deferred until withdrawal in the IRA.

Finally, the traditional IRA is a good choice for the investor who would prefer a Roth but doesn't qualify. Under rules that took effect Jan. 1, anyone can convert a traditional IRA, either deductible or non-deductible, into a Roth. Previously, individuals and couples earning more than $100,000 couldn't convert. Now you can put money into a traditional IRA and then quickly convert it to a Roth.

Although you have to pay tax when you convert, withdrawals from the Roth will be tax-free. Conversions are good for investors who think their tax bracket will be higher when money is withdrawn, since they can pay tax now to avoid a bigger tax later. Use the Roth IRA Conversion Calculator to see if this makes sense for you.

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