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Ally Invest Review 2021

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Reviewed By

Ally Invest offers self-directed trading for the DIY investor, as well as automated trading for those who would prefer a robo-advisor approach. Low investment minimums, commission-free stock and exchange-traded fund (ETF) trades and a variety of investment options are some of this online trading platform’s best features.

Trading with Ally Invest could be suitable for both beginning investors who are just getting started with portfolio building and more-experienced investors focused on growing their wealth. There are no physical branches, but that’s typical of many robo-advisors. This Ally Invest review offers a closer look at how the platform works.

Ally Financial Inc.
Visit Ally Secured
on Ally Invest Managed Portfolios’s secure website
The bottom line: Ally Invest offers affordable, convenient trading for both DIY investors and those who prefer a managed portfolio approach.

  • Commission-free stock and ETF trades
  • No account minimums for self-directed trading
  • Invest automatically with portfolios for every investor type

Best for...
  • DIY investors who are comfortable with self-directed trades
  • Investors seeking low-cost managed portfolio options
  • Beginning investors who are starting with smaller amounts of money
  • Active investors who want to trade commission-free
Minimum investment
  • $0 for self-directed trading; $100 for automated trading
Management fee
  • $0 for cash-enhanced portfolios; 0.30% for market-focused portfolios
Accounts offered
  • Individual brokerage accounts
  • Joint brokerage accounts
  • Custodial brokerage accounts
  • Traditional IRAs
  • Roth IRAs
  • Rollover IRAs
  • Coverdell Education Savings Accounts
Access to human advisorsNo
Banking servicesYes, through Ally Bank

What is Ally Invest and how does it work?

Ally Invest is a robo-advisor that allows you to build a portfolio in one of two ways: You can choose between self-directed trading, if you’re a hands-on investor, or investing automatically with managed portfolios. Investment account options include individual and joint brokerage accounts, as well as traditional, Roth and rollover IRAs.

While Ally Invest does utilize human investing experts to build its managed portfolios, the management process itself is automated — that means you won’t have access to a human financial advisor. But you do get the benefit of a user-friendly trading platform, customer support available by phone and online chat and access to a variety of research tools to help guide your investment decision-making.

Pros

  • Commission-free trades: Ally Invest charges no commission fees for trades of listed U.S. stocks and ETFs. You also pay no commissions on options trades.
  • Varied investment options: With Ally Invest you can build a diversified portfolio that includes stocks, ETFs, options, bonds and mutual funds. You also have the option to trade on margin, meaning you can use borrowed funds to trade.
  • Multiple managed portfolio options: If you choose to invest with managed portfolios, you can select one of four options based on your goals and risk tolerance. Those include core, income, tax-optimized and socially responsible portfolios.
  • Zero advisory fees: Pay zero advisory fees when you invest in a cash-enhanced managed portfolio. Thirty percent of your portfolio is allocated to cash, which has a variable interest rate.

Cons

  • No direct fractional shares: While you can invest in fractional shares with stocks that have a Dividend Reinvestment Plan (DRIP), you can’t purchase them directly.
  • No crypto or futures trading: If you’re interested in trading cryptocurrency or futures, you’ll need to consider another robo-advisor. Ally Invest doesn’t offer either one.
  • Higher account minimum for margin trading: While there are no account minimums for self-directed trading, you’ll need at least $2,000 to add margin trading to your account.
  • Advisory fee for market-focused portfolios: Cash-enhanced portfolios have no advisory fees but if you choose a market-focused portfolio, you’ll pay 0.30% annually.

Ally Invest investment approach

Investment options
  • Commission-free stocks
  • Commission-free ETFs
  • Commission-free options
  • Bonds
  • Mutual funds

Tax loss harvesting
Portfolio rebalancing
Smart Beta
Socially Responsible Investing
Fractional shares

Asset allocation

With self-directed trading, you can choose how to allocate your portfolio among stocks, ETFs, options, mutual funds and fixed-income securities. Ally Invest Managed Portfolios are goal-based in their design and construction, and there are four managed portfolio options to choose from:

  • Core: Core portfolios are diversified across domestic, international and fixed-income assets. This portfolio is suited for hands-off investors and can be tailored to individual risk tolerance.
  • Income: Income portfolios are geared toward investors who want a lower risk profile while enjoying higher dividend yields.
  • Tax optimized: Tax-optimized portfolios are focused on increasing tax efficiency. As such, these portfolios lean heavily on low-cost ETFs.
  • Socially Responsible: Socially Responsible portfolios focus on companies that are committed to ESG principles. That includes efforts to promote sustainability, energy efficiency and eco-friendliness.

Tax strategy

Ally Invest doesn’t offer tax-loss harvesting or smart beta as tax-management tools. However, you can maximize tax efficiency by choosing Tax optimized as your managed portfolio option. These portfolios invest in low-cost ETFs and other assets that offer tax advantages, such as municipal bonds.

Ally Invest fees

  • Annual management fee: $0 for cash-enhanced portfolios; 0.30% for market-focused portfolios
  • Investment expense ratios: 0.03% to 0.89% for ETFs

Ally Invest is a fee-friendly trading platform overall. On the self-directed trading side, there are no trading fees for stocks and ETFs. You pay no commission to trade options, though there is a $0.50 per contract trading fee.

Load mutual funds have no commission fee, while no-load funds have a $9.95 commission to buy or sell. Bonds and treasuries trade at $1 apiece, while CDs trade for $24.95 per transaction.

What you’ll pay to invest with managed portfolios depends on whether you choose a cash-enhanced or market-focused option. A cash-enhanced portfolio keeps 30% of your account balance in cash, which earns a variable interest rate. There’s no advisory fee for this option.

If you go with a market-focused portfolio, you’ll have a much lower cash allocation of roughly 2%, but you’ll pay a 0.30% annual advisory fee. It’s important to consider what type of trade-off you’d prefer: No fee with more of your portfolio devoted to cash, or a lower cash allocation with an annual fee.

Ally Invest features and tools

Easy cash movement

Ally Invest doesn’t offer a cash management account option, but you can easily move money between your Ally Invest account and deposit accounts with Ally Bank.

You can transfer up to $250,000 per day from an Ally checking, savings or money market account to your Ally Invest account. Transfers can be completed in minutes, allowing you to move money quickly if needed. Plus, depending on which type of account you have with Ally Bank, you may earn a competitive interest rate on your deposits.

Dividend reinvestment

Dividend reinvestment programs (DRIPs) allow you to reinvest dividends into additional stock shares, including fractional shares. Though, again, you can’t purchase fractional shares directly with Ally Invest.

Ally Invest does, however, offer dividend reinvestment for eligible securities. You can enroll in this feature for all eligible securities automatically, or pick and choose specific ones for dividend reinvestment. Holding dividend-paying stocks in your portfolio can be a simple way to build wealth over time if you aren’t relying on dividends for income.

Powerful trading platform

Ally’s trading platform helps with building a portfolio, and its featured tools include watchlists, ETF screeners, research and market data and investment calculators. Features are customizable, so you can use the ones you need without getting distracted by the ones you don’t.

Ally Invest user experience

In terms of user experience, the Ally Invest website is easy to navigate, as is its mobile app. You can use the mobile app to make the same moves you can through the website, including accessing research and analysis tools, scheduling trades and monitoring securities watchlists.

Ally Invest also has customer support available to you in case you run into a problem. The live chat feature is a plus, as not all online brokers allow you to connect with customer support this way. Initiating a test chat revealed a very quick response time.

Help is also available by phone at 855-880-2559, or you can send secure messages via email. Ally also has an online Help Center, where you can find answers to basic account management questions.

Ally Invest safety and security

SIPC protection

Ally Invest is a member of the Securities Investor Protection Corporation (SIPC), which insures investors up to $500,000 (the limit for cash claims is $250,000). Ally Invest‘s clearing firm, Apex Clearing, offers an additional policy to supplement SIPC coverage. This coverage, which has a $150 million aggregate limit, kicks in when SIPC coverage limits are exhausted.

Online security tools

Ally Invest uses a number of tools to keep customer accounts secure online. Those include firewalls, Secure Socket Layering (SSL) and secure encryption. While Ally Invest doesn’t specifically offer two-factor authentication as a security measure, you may be asked to provide security code if suspicious login activity is detected.

Is Ally Invest worth it?

Ally Invest could be appealing to investors who are comfortable making trades on their own, as well as those who prefer a managed approach. The low investment minimums make it easy for investors to get started, while commission-free stock and ETF trades should appeal to the cost-conscious.

One advantage Ally Invest offers over other robo-advisors is the lack of an advisory fee if you choose the cash-enhanced portfolio. But again, it’s important to consider whether taking a larger cash position in your portfolio to avoid a fee makes sense.

Alternatives to Ally Invest

 Account minimumAnnual feeAccounts offered
Ally Invest$0 for self-directed trading; $100 for managed portfolios$0 for cash-enhanced portfolios; 0.30% for market-focused portfoliosIndividual brokerage accounts
Joint brokerage accounts
Traditional IRAs
Roth IRAs
Custodial accounts
Rollover IRAs
Coverdell ESA
Robinhood$0N/aIndividual brokerage accounts
Wealthfront$5000.25%Individual brokerage accounts
Joint brokerage accounts
Trust accounts
Traditional IRAs
Roth IRAs
SEP IRAs
401(k) rollover
529 college savings accounts

Ally Invest vs. Robinhood

Robinhood was one of the earliest online brokerages to offer commission-free trades. You can trade stocks and ETFs with zero commissions and no account minimums inside an individual brokerage account. Robinhood also offers options trading, but you can’t trade mutual funds, bonds or forex through the platform.

Robinhood doesn’t offer managed portfolios the way Ally Invest does, but there are some elements here that might appeal to newer investors. When you open an account with Robinhood, you can invest using fractional shares with as little as $1. You can also use a cash sweep feature to earn interest on unused cash balances in your brokerage account.

Open a Robinhood account Secured
on Robinhood’s secure website

Ally Invest vs. Wealthfront

Wealthfront is designed for passive investors who want to build wealth over time with low advisory fees. You’ll need $500 to open an account with Wealthfront, which is higher than the $100 required for Ally Invest, but the annual advisory fee is slightly lower, at 0.25%. Again, you could avoid this fee with Ally Invest by choosing a cash-enhanced portfolio, although the rewards from a cash-heavy portfolio may not be worth it.

You can’t purchase fractional shares with Wealthfront, similar to Ally Invest, but you do get the benefit of tax-loss harvesting. Wealthfront also offers smart beta once your account balance reaches $500,000.

Open a Wealthfront account Secured
on Wealthfront’s secure website

All information included in this profile is accurate as of 1/22/2021. For more information, please consult Ally Invest’s website.

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Fidelity Review 2021

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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The Fidelity Account is a low-cost brokerage account offered by Fidelity Investments that allows investors to trade U.S. stocks, exchange-traded funds (ETFs) and options online with $0 commission fees. Fractional share trading is also available through the Fidelity mobile app.

The account is a standout for its fee structure and range of investment choices. Broker-assisted trades are pricey, but otherwise, there are few downsides. This Fidelity review is designed to help you decide if it’s the right brokerage for you.

Fidelity Brokerage Services LLC
Visit Fidelity Secured
on Fidelity’s secure website
The bottom line: Fidelity may appeal to beginning and more experienced investors alike with its diverse investment options and competitive pricing.

  • Full-service broker with a strong brand reputation
  • Extensive options for all investor types
  • Low or no fees/commissions on most products

Minimum deposit$0
Account types
  • Individual brokerage accounts
  • Joint brokerage accounts
  • Cash management accounts
  • Fidelity accounts for business
  • Rollover IRA
  • Traditional IRA
  • Roth IRA for kids
  • Inherited IRA
  • Inherited Roth IRA
  • SEP IRA
  • Self-employed 401(k)
  • SIMPLE IRA
  • Investment-only plans for business
  • 401(k) plans for small business
  • Managed accounts with Fidelity Go
  • 529 college savings accounts
  • Coverdell ESAs
  • Health Savings Accounts
  • ABLE accounts
  • Trust accounts
Tradable securities
  • U.S. and international stocks
  • ETFs from Fidelity, iShares and other industry leaders
  • Options
  • Fidelity Mutual funds and funds from other companies
  • Bonds
  • Certificates of deposit
  • Precious metals
Fees
  • $0 commission fees for online U.S. stock, ETF and Options trades
  • Additional fees apply for broker-assisted trades and purchases of transaction fee non-Fidelity funds
  • No annual account fee
Sign-up bonusNone currently available

What Fidelity offers and who it’s for

Fidelity is a full-service online brokerage that offers an extensive range of investment Options, including stocks, Mutual funds, ETFs, Options and precious metals. Both beginning and more experienced investors may find Fidelity‘s low trading costs an attractive incentive for opening an individual or joint brokerage account. You also may choose to invest in an IRA or Solo (401)k through Fidelity to save for your retirement.

Fractional share trading is something else that sets Fidelity apart, as not all online brokerages offer this option. In terms of where Fidelity tends to fall short, cryptocurrency and futures trading aren’t included in the list of investment Options. And if you need a broker’s help to execute a trade, that means paying an added fee.

Pros

  • Wide range of investment choices: Fidelity makes it relatively simple to build a diversified portfolio with its range of investment Options, which includes both Fidelity and non-Fidelity funds.
  • Low-cost trading: Like a number of online brokerages, Fidelity has adopted a $0 commission fee model for online trades of U.S. stocks, ETFs and Options.
  • No account minimum: While some brokerages require a larger minimum deposit to open an account, Fidelity allows you to get started with a $0 minimum.
  • Extensive research tools: Fidelity is generous when it comes to providing investors with the research and analytical tools they need to make investment decisions.

Cons

  • Broker-assisted trades will cost you: Getting broker assistance in executing a trade will require paying an additional fee.
  • No crypto or futures: Investors who are interested in trading cryptocurrency  or futures will need to look elsewhere.
  • High mutual fund fees: Investing in non-Fidelity funds could trigger a steep trading fee.
  • Holding period for initial withdrawals: While you can open and fund an account with Fidelity online in minutes, it can take up to 10 business days to verify banking information for withdrawals from your account.

Fidelity fees and costs

Option trading fees$0 + $0.65 per contract for online trades; $12.95 + $0.65 per contract for FAST trades (by phone); $32.95 + $0.65 per contract for broker-assisted trades
Stock trading fees$0 for online trades of U.S. stocks; $12.95 for FAST trades (by phone); $32.95 for broker-assisted trades
ETF trading fees$0 for online trades of U.S. stocks; $12.95 for FAST trades (by phone); $32.95 for broker-assisted trades
Mutual fund trading fees$0 for Fidelity funds; $0 on purchase and $49.95 on redemption for no transaction fee non-Fidelity funds held less than 60 days; $49.95 per purchase and $0 at redemption for transaction fee non-Fidelity funds
Bond and CD trading fees$0 for new issues, $1 per bond for secondary issues; $0 for online U.S. Treasury auctions and secondary issues; $19.95 for representative-assisted U.S. Treasury auctions and secondary issues
Account fees (annual, transfer, inactivity)No annual fee, no transfer fees and no inactivity fees; only additional fees may be:

  • Up to 3% of principal for foreign exchange wire transfers
  • $50 Depository Foreign Trust Company foreign settlement fee
  • $100 stock certificate transfer fee
  • 1% of principal foreign dividends and reorganization transaction fee
  • $32.95 per margin liquidation

Fidelity has followed the example of other online brokerages and moved toward commission-free trading for U.S. stocks, ETFs and  Options when trading online. You can also trade Fidelity‘s impressive collection of Mutual funds with $0 commission fees.

You will, however, run into fees if you want to trade non-Fidelity funds. Again, you’ll pay $0 on purchase for no transaction fee funds from issuers other than Fidelity and $49.95 at redemption for funds held less than 60 days. Transaction fee non-Fidelity funds require a $49.95 fee per purchase but charge $0 on redemption.

Fidelity investing tools and research

Online trading tools

Fidelity‘s online trading platform includes monitoring tools to help investors:

  • Track stock price movements and profit/loss positions in real time
  • Research specific market sectors
  • Execute trades
  • Research individual securities
  • Read the latest market news
  • Chart their comprehensive financial picture

Investors have access to an ETF screener that allows them to compare more than 2,000 commission-free ETFs, along with mutual fund, stock and bond screeners. Fidelity aggregates investment news and reports from a variety of well-known sources, including Reuters, Zacks Investment Research and Argus Analyst.

Mobile trading tools

The Fidelity mobile app allows investors to track their portfolio on the go. The app, which is free to download for iPhone and Android, makes it easy to:

  • Manage your portfolio and watch lists
  • Execute trades
  • Invest with fractional shares
  • View balances and get real-time quotes
  • Set up account alerts and notifications
  • Save articles and take notes

The most notable feature of the Fidelity mobile app is the ability to trade fractional shares. Through fractional share investing, you can purchase more expensive stocks in smaller increments. With dollar-based investing from Fidelity, you can trade shares of more than 7,000 U.S. stocks and ETFs for as little as $1. That could be appealing to newer investors who are just getting started and don’t have a lot of money to put into the market.

Active Trader Pro

Active Trader Pro is Fidelity‘s dynamic online trading platform. To use Active Trader Pro, you have to request access through Fidelity. You may access this feature automatically if you trade 36 times or more in a rolling 12-month period. If you’re approved for Active Trader Pro, it’s free to use.

Once you download Active Trader Pro for PC or Mac, you’ll have access to tools and research that allow you to take an even deeper dive into trading. For example, the Trade Armor feature allows you to visualize risk and reward for a particular investment while tracking price movements. Real-time analytics make it easy to track technical indicators for stocks to identify trading opportunities.

As the name suggests, Active Trader Pro is designed for investors who take a more active approach to portfolio management. While it’s accessible for active Fidelity investors of any skill level, it may be a little overwhelming for a beginner.

Fidelity user experience

Between online and mobile investing, Fidelity makes investor accounts easily accessible. If you’re unfamiliar with the Fidelity website and its layout, however, you could get lost when moving between different pages. The mobile app, on the other hand, is easier to navigate as you move through different screens and tabs.

In terms of customer service, Fidelity offers support by phone, live chat and secure messaging. Phone support is available 24/7 by calling 800-343-3548. You can also use live chat to connect with Fidelity Support, but it may take time to be connected to a representative. During one attempt, we were put in the queue at number 24 in line.

We also called customer support, which responded promptly with a hold time of less than a minute. Likely, this will all depend on the volume of calls at the time of your attempt. The customer service representative we spoke with on the phone was knowledgeable and able to answer all of our questions, which included requesting information on minimum deposits and how to withdraw money from a brokerage account.

Fidelity investor education

The Fidelity Learning Center offers numerous educational resources to help investors shape their portfolio strategy. The educational tools on hand include:

  • Live webinars
  • On-demand webinars
  • Weekly Fidelity classes for beginning investors
  • Interactive coaching sessions
  • Investment guides
  • Articles

While some online brokerages take a bare-bones approach to investor education, Fidelity equips you with plenty of tools to make informed decisions. These tools are free to access as a Fidelity customer, which is great if you don’t have a dedicated financial advisor yet because you’re unable or unwilling to pay a fee for professional investment advice.

Fidelity security

SIPC coverage

The Securities Investor Protection Corporation (SIPC) insures against financial losses if a brokerage goes bankrupt. All Fidelity brokerage accounts have SIPC coverage, which extends to money market funds as well as other securities. The coverage limit is up to $500,000, including a $250,000 limit for cash held inside your brokerage account.

Online security

Fidelity uses a number of strategies to protect client accounts online. That includes the use of two-factor authentication to verify accounts, the ability to lock accounts to prevent money transfers, security text alerts and voice recognition through Fidelity MyVoice when accessing your account by phone.

Customer protection guarantee

Fidelity offers a Customer Protection Guarantee to reimburse investors for losses associated with unauthorized account activity. That includes both cash and securities held in Fidelity brokerage accounts. This coverage is automatic, but to use this benefit, you must contact Fidelity at 800-544-6666 as soon as you become aware of any suspicious or unauthorized activity.

Alternatives to Fidelity to consider

Fidelity could be a good fit for investors who want to make commission-free trades, invest with fractional shares or take advantage of Fidelity‘s extensive research and investment tools. It’s important, however, to consider where other brokerages might outshine Fidelity in terms of cost, investment Options and overall user experience. Here are two other Options to compare to Fidelity when opening a brokerage account.

Fees

$0.00 per trade

Account Minimum

$0

Promotion
N/A
Fees

$7.00 per trade for the first 25 trades per year, $20 per trade thereafter for accounts with less than $50,000

  • $7 per trade for accounts with $50,000 to $500,000
  • Account Minimum

    $1,000 for Vanguard Target Retirement Funds and Vanguard STAR® Funds; $3,000 for most other Vanguard funds

    Promotion
    N/A
    Fees

    $0.00 per trade

    Account Minimum

    $0

    Promotion
    N/A

    Fidelity vs. Vanguard

    Vanguard is a well-known name in the online brokerage space, thanks largely to its suite of low-cost index funds and ETFs. In terms of fees and account minimums, Fidelity and Vanguard are almost identical, though it will cost you slightly more per Options contract with the latter.

    In terms of investment offerings, they’re similar, but the main point to consider is whether you lean more toward Fidelity funds or Vanguard funds. When it comes to user experience and investment tools, Fidelity has a slight edge with Active Trader Pro. Fidelity‘s website is also easier to navigate.

    Open a Vanguard account Secured
    on Vanguard’s secure website

    Fidelity vs. TD Ameritrade

    Fidelity and TD Ameritrade are neck and neck in terms of investment costs and minimums, though you will need at least $2,000 to trade on margin with TD Ameritrade. But this brokerage does offer a few things Fidelity doesn’t, including cryptocurrency and futures trading, as well as multiple online trading platforms designed to meet different investors’ needs.

    One other thing worth pointing out is that TD Ameritrade‘s broker-assisted trade fee is lower than Fidelity‘s, at $25 versus $32.95. Whether it makes sense to choose Fidelity over TD Ameritrade or vice versa may ultimately come down to which brokerage’s funds you prefer.

    Open a TD Ameritrade account Secured
    on TD Ameritrade’s secure website

    All information included in this profile is accurate as of 1/14/2021. For more information, please consult Fidelitys’s website.

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    What Is a Non-Deductible IRA?

    Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

    Written By

    A non-deductible IRA is a way of making contributions to an individual retirement account, not a specific type of IRA.

    Anyone can contribute money to a Traditional IRA, no matter how much they make. But you can only make tax-deductible contributions to a Traditional IRA if your modified adjusted gross income (MAGI) is below certain limits set by the IRS. Meanwhile, Roth IRAs are only available to people whose income is below certain thresholds.

    Non-deductible IRA contributions make sense for your retirement planning only when your annual income exceeds the limits for a Traditional IRA or a Roth IRA.

    How does a non-deductible IRA work?

    A non-deductible IRA strategy is when you contribute money to a Traditional IRA but don’t get the tax deduction benefits, says Garrett Konrad, chief operating officer at registered investment advisory firm IFC.

    Tax deductions reduce your annual taxable income, thereby lowering your tax bill or increasing your tax refund. Contributions to a Traditional IRA are partially or fully deductible, depending on your income, filing status and whether you’re covered by a retirement plan through your employer. For 2021, you can deduct your entire contribution to a Traditional IRA if:

    • You’re covered by a retirement plan at work, file as a single person or as a head of household, and have a modified adjusted gross income (MAGI) of $68,000 or less.
    • You’re part of a married couple filing jointly with a MAGI of $105,000 or less and you’re covered by an employer’s retirement plan.
    • If you file as a single person, head of household or as a married couple filing jointly, but you’re not covered by an employer’s plan.

    If your tax filing status or income puts you out of range of the Traditional IRA caps outlined above, that’s when you make non-deductible IRA contributions.

    Alternatively, you might consider a non-deductible IRA if your income makes you ineligible for a Roth individual retirement account. Roth IRAs provide tax-free distributions in retirement, but you can’t contribute to one if your annual income is too high. For 2021, you can’t contribute to a Roth IRA if:

    • You make more than $140,000 as a single filer or head of household.
    • If you make more than $208,000 as a married couple filing jointly.

    Non-deductible IRA contributions are part of the backdoor Roth IRA strategy (more on that later). Just keep in mind that non-deductible IRAs are subject to the same maximum contribution limits as Traditional and Roth IRAs. For the 2021 tax year, you can contribute up to $6,000 to either type of IRA, or $7,000 if you’re age 50 or older.

    How is a non-deductible IRA taxed?

    A non-deductible IRA allows you to defer taxes but not escape them completely. After you pay taxes on your income, you can make non-deductible IRA contributions to a Traditional IRA. The contributions will not be taxed when you withdraw them in retirement, since you’ve already paid income taxes on them. However, you will owe income taxes on the earnings you withdraw from the account.

    “Because it is a type of contribution, not a type of account, you need to be careful when non-deductible IRA contributions get mixed into an account that previously had tax-deductible contributions in it,” Konrad said. “Tax-deductible contributions are taxed upon withdrawal on the entire amount, while non-deductible contributions are only taxed on the growth of the contribution.”

    Non-deductible IRA example

    Take a simplified example of a Traditional IRA that has $1,000 in deductible contributions and $1,000 in non-deductible contributions. Assuming each contribution grows by $100, the account balance would be $2,200.

    If you were to withdraw the entire deductible contribution, the $100 in earnings from the deductible contribution, and the $100 in earnings for the non-deductible contribution, this $1,200 sum would be taxed. A withdrawal of the $1,000 non-deductible IRA contribution would be not taxed.

    Now imagine that you have decades of deductible and non-deductible contributions — plus earnings from both sorts of contributions — in your Traditional IRA. You can imagine how managing your portfolio’s taxes would become tricky once you begin taking distributions in retirement.

    Nondeductible IRA and required minimum distributions (RMDs)

    There’s another factor to be aware of: Non-deductible IRA contributions are subject to required minimum distributions or RMDs. With Traditional IRAs, including those that hold non-deductible contributions, the IRS requires you to begin taking money from your account at age 72, the so-called RMDs.

    The amount you’re required to withdraw is based on your account balance and life expectancy. If you don’t take your RMDs on schedule, the IRS can hit you with a steep tax penalty of 50% of the amount you were required to withdraw.

    Why use a non-deductible IRA?

    The most popular reason for making non-deductible IRA contributions is because you’ve exceeded the income limits to deduct Traditional IRA contributions or because you can’t contribute to a Roth, says Adam Bergman, president of the IRA Financial Trust and IRA Financial Group in Miami.

    Even if you’re not able to deduct your contributions for the year or contribute to a Roth, a non-deductible IRA allows you to fully utilize an IRA as part of your retirement strategy. You can still max out the annual contribution limits this way, meaning you have more money in your IRA that can grow as a result of compounding interest.

    The other reason to make non-deductible IRA contributions is as a stepping stone to a backdoor Roth IRA, says Jonathan Bednar, a certified financial planner at Paradigm Wealth Partners in Knoxville, Tenn.

    Non-deductible IRA contributions and the backdoor Roth IRA

    A backdoor Roth IRA is a way to get a Roth IRA and enjoy its tax benefits when you’d otherwise be ineligible for the account due to an income level that was above the IRS thresholds outlined above.

    To execute a backdoor Roth IRA, you’d first open a Traditional IRA and then make a non-deductible IRA contribution. Next you convert it to a Roth account. If done immediately after making the non-deductible contribution, there’d be no taxes owed and you could reap the benefits of tax-free distributions of a Roth IRA once you retire.

    However, you do have to watch out for the pro rata rule, Bergman says. This rule dictates that if you have both pretax and after-tax contributions in your IRAs, you have to use the aggregate balance to determine how much tax you’ll owe when you convert to a Roth account.

    Also, keep in mind that if you’re converting your entire Traditional IRA, including both deductible and non-deductible contributions, all of the money would be taxable in the year you make the conversion. This can temporarily increase your tax liability, so it’s important to ensure you have cash on hand to cover any taxes owed associated with a Roth conversion.

    Who should use a non-deductible IRA?

    A non-deductible IRA isn’t the best approach for every investor when planning for retirement. Making non-deductible contributions to an IRA usually only makes sense in one of two scenarios.

    “There is really no good reason to make an after-tax contribution other than not being able to make either a pretax or Roth IRA contribution,” Bergman said. “The after-tax contribution does not include a tax deduction and does not have tax-free growth as a Roth IRA.”

    Making non-deductible IRA contributions could come in handy if you’ve experienced a life event that changes your tax profile, such as getting a substantial raise at work. You wouldn’t be excluded from making IRA contributions based on your income. At the same time, you could further grow your retirement wealth by maxing out your retirement contributions at work.

    More importantly, adding money to a non-deductible IRA could be a good choice if you’d like to include a Roth IRA in the mix when planning for retirement. Along with tax-free distributions, the other benefit of a Roth is the ability to avoid RMDs. This means that your money can continue growing indefinitely in retirement until you need to begin withdrawing it.

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