Understanding IRA & Roth IRAs

DISCLAIMER: I’m not a financial planner. The opinions stated in this blog post are my opinions based on my current financial portfolio and the hours of reading and research. I suggest everyone to also perform your own research since everyone’s financial portfolio are uniquely different.

Last year (2020), I did a deep dive into my current retirement portfolio and adjusted my investments to mainly have small, mid and large cap value and also large cap growth. This balance seemed reasonable at the time. This past year, I opted to hire a financial planner for just 1 year basis to check on how I’m doing with my overall portfolio and to suggest on areas I might need improvement on. Overall, he was fairly impressed at the state of my portfolio and had a few suggestions that I plan on adopting. One of these suggestions is to fund a non-deductible IRA account.

What is a non-deductible IRA? If do you a google search, many of the website talk about non-deductible IRA as a step to for the back door Roth IRA. Specifically, you’re transferring after tax (non-deductible) money into an IRA account which will immediately be converted into the Roth IRA. The money in the Roth IRA will grow and more importantly not be taxed during withdrawal. Keep in mind, some of the search results may point you towards funding a deductible IRAs and then a conversion into a Roth IRA. There are some key differences and I spent a good amount of time reading and re-reading to try to understaand these differences.

1) The total allowable contribution to an IRA (Individual Retirement Account) or a Roth IRA (or any combination of the two) is currently $6000 for 2021. If you’re older than a certain age, you can contribute more.

2a) An IRA comes in two types: deductible and non-deductible. A deductible IRA allows a person to take tax deductions whereas a non-deductible does not allow for tax deductions.

2b) To fund a deductible IRA, a person must meet certain income requirements for the tax deduction. The amount of tax deduction is determined by the income level. Since a person contributed pre-tax dollars into an IRA during working years, the distributions during retirement are then taxed accordingly to the income tax brackets during retirement. This assumes that retirement income in during retirement will be at lower tax bracket than during a person’s working years.

2c) To fund a non-deductible IRA, a person will need to contribute “after-tax” money into the IRA. Since this person is outside the income requirements, he/she can no longer benefit from the tax deduction. Form 8606 must be sent to the IRS in order to note the after-tax contributions. It is important to keep a record of all the Form 8606s so that proper accounting can be done during retirement and distributions. Any growth in the IRA are subject to taxes. However, the original contribution amount will not be taxed (as long as you keep a record of form 8606).

2d) Reading up on deductible and non-deductible IRAs, it seems from a tax perspective funding only non-deductible IRAs make sense. There’s some tax liability associated with mixed deductible and non-deductible accounts

3) To fund a Roth IRA directly, a person must also meet certain income requirements. The direct contribution amount also varies by income requirements. Roth IRAs are slightly different than IRAs in that Roth IRAs are funded with after-tax contributions. Furthermore, during retirement, the distributions from Roth IRA are NOT taxed regardless of growth. This makes Roth IRAs one of the best types of retirement investment accounts. For a young person just starting their working career, I recommend to fund a Roth IRA yearly and invest in mutual funds that are indexed (follow) the S&P500. Using time and the safe mutual fund growth, the account value will grow exponentially over time.

4) To fund a backdoor Roth IRA, a person must first fund a non-deductible IRA and then immediately convert the amount into a Roth IRA.

There are actually some difficulties associated with non-deductible IRAs. The main issue seems to be the record keeping needed to keep the account in order. To add more difficulty, if a person also has a deductible IRAs, the tax liabilities in maintaining both types of IRAs come into play via the “Pro-rata rule” which from my understanding will start to tax a part of the contribution/rollover becuase of the total deductible IRAs in the account. Fortunately, I don’t have any deductible IRAs.

I wish I had known more about Roth IRAs much earlier. Being able to start earlier would have been nice especially since there would be more time for the investments to grow. In this case, time = money truly is accurate. If at all possible, always try to invest in Roth IRAs or leverage non-deductible IRAs for backdoor Roth IRAs. The tax free withdrawals is an amazing tool for maximizing retirement income.


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