IRA vs Investing Directly in Mutual Funds or Stocks?

I max out my contribution to the 401k. I do not qualify for a Roth 401k. I can still invest up to $5000 in a tradtitional IRA with taxed earnings but would someday be paying ordinary income tax rates on withdrawls from the IRA.

Instead of investing in the traditional IRA wouldn't I be better off investing directly in a mutaul fund or stocks where my earnings would be treated as capital gains (currently 15%)?

Thank You

Thanks for the answers but I should have been a little more clear. I do exceed the limits for a Roth IRA and therefore can only take advantage of the tradtitional post tax IRA up to $5000 the earnings on one of these is treated as ordinary income upon withdrawing right?).

Just wondering if I should do this or invest in: 1- a taxable IRA (includes stocks and/or funds) or, 2 - stocks, or 3 - funds? All three would hopefully someday provide earnings which would be treated as capital gains (that will - i agree probably go up eventually).

Thanks so very much!

I am in the same boat. What I have decided to do is go ahead and do the nondeductible Traditional IRA each year.

Here's why: There is a tax law on the books that, in 2010, will allow people in our situation to rollover our traditional IRAs to Roth IRAs without regard to our income level. Of course, we'll have to pay tax on any appreciation, but then the IRAs will appreciate tax-free, and any withdrawals at retirement will be tax free as well. The tax may be paid in 2010, 2011 and/or 2012.

That's what I do. I invest mostly in index funds. All capital gains are deferred until I sell. Dividends are currently taxed at 15%, but this may change soon, and go back up to marginal rates.

If you have kids, you can invest in tax-free accounts for their college such as 529 plansand Coverdell plans. you can read about this at
http://www.savingforcollege.com

You can invest in stocks or mutual funds within an IRA - its not an either/or situation. I would suggest you start a Roth IRA instead of contributing to a conventional one. Your gains within a Roth are tax-free.

One thing you are forgetting is that all of your Traditional IRA contributions are actually pre-tax (even though you are using after-tax cash to do so), since these contributions will be deducted from your Adjusted Gross Income on your tax return.

So it really comes down to this: what is your investment strategy?

Retirement? If so, put in Roth IRA first, then a traditional IRA.

If you are just saving money for future expenses like a new car or a down payment on a house, you should just put in a good mutual fund. IMO, stocks are too risky if you don't have enough money to properly diversify.

Hope this helps.

Given your question and options available, I am assuming that your income is too high to qualify for a Roth IRA or tax-deductible IRA. If this is incorrect, go with the Roth or Tax deductible, it's a better option.

If your purpose for the savings is retirement, and you plan on taking it out after age 59 1/2, I would indeed suggest the taxable/traditional IRA. You would defer the capital gains tax, and hopefully your tax bracket will be lower when you retire - if my assumption is right, your tax bracket is REALLY high now! The capital gains tax isn't going to stay at 15% long-term, it will go up somewhere along the way, and the IRA protects you from that increase.

Plus, if your income drops below the income maximum for Roth IRA rollovers, you can roll your taxable IRA over into a Roth IRA tax-free! That could be a major bennie!

However, if you are maxing out your 401(k) to the tune of 15k+/year, you may be pretty well set for retirement. If you want your cash earlier than 59 1/2, go with the taxable account.

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New response:

Personally, I can see arguments either way. You could go with a taxable account. If you do this, you should be careful to invest only in stocks and funds that are tax-friendly, meaning that they don't trade much, don't distribute much in dividends, and don't distribute much in capital gains. This is a significant restriction in your investment choices. However, you get a big advantage in the fact that if you need the money before you are 59 1/2, you can have it.

The IRA gives you the flexibility not to worry about how tax-advantaged your investments are, because it simply doesn't matter. It also gives you the benefit that if you have one year somewhere down the road when your taxable income is low, you can roll the whole thing over into a Roth IRA, which is a big benefit if you can pull it off. But, the big drawback is that you can't touch the money until you are 59 1/2.

As for stocks vs. funds, the main thing is to have a sensible asset allocation across all of your retirement investment accounts. Since the bulk of your money is in the 401(k), I would put the IRA or taxable account money into asset classes you can't get with your 401(k) or asset classes where your 401(k) options suck. For example, if you want to put 10% of your portfolio into commodities funds, you probably can't do it in your 401(k), so do it in your other accounts. If your 401(k) fund has emerging markets funds that charge 3% per year fees, find one that charges less and buy it in your IRA. Lastly, if you like to play with stocks, and want to keep a small part of your portfolio aside for investing/speculating in individual stocks, you can do that in your IRA.

In my case, my 401(k) really only has good investment options for large US firms and large international firms. All the other funds in the plan charge high fees. So, my 401(k) is all large US and international equity funds, and my IRAs handle the rest of the investment classes like bonds, emerging markets, small-cap stocks, and commodities.

I wouldn't do the traditional IRA with post tax dollars. Yes, current long term capital gains tax is currently at 15%. That will be repealed by whoever gets elected next year and will increase to 28%. The three candiates left were all against the tax cuts that expire very soon.

I might be missing something, but the way I see it, it does not make any difference HOW the money was earned...capital gains or not...YOU get taxed on IRA withdrawals as INCOME, period.... so it depends on what your bracket is at that time...not how you got it !!
Still in all...if it's all that's left to you under the current system...take the little tax breaks yearly as they come ( with the trad IRA)...
...or go into buying tax-free municipal bonds in a Fidelity/ Schwab/ Vanguard account....just take the little gains and re-invest for years... smaller lump at the end, BUT no tax-man with his hand out !!
Back to the first point: if you have a " brokerage account" ( not an IRA) ..THEN your gains are figured at that 15% rate... but it's all a lot of paperwork for you or your tax-man along the way. ...( still gets added to your income...raises your adjusted gross, etc.)