Taxable Accounts vs. Non-Deductible IRA

Even when you can't deduct your traditional IRA contribution, you still get the advantage of tax-sheltered growth. This means that no matter how often the investment creates otherwise taxable income, you don't have to pay any of those taxes until you take distributions. For example, if you were trading stocks in your nondeductible IRA, you won't have to pay taxes on the gains every time you sold a stock — which helps your gains compound at a faster rate.

The IRS restricts the maximum nondeductible contribution to your traditional IRA each year, so there's only so much you can put in. As of 2012, the maximum yearly amount is $5,000 ($6,000 if you're 50 and older). In addition, if you take distributions before you turn 59 1/2, the taxable portion of the distribution is hit with a 10-percent additional tax penalty unless an exception applies (such as certain medical expenses). Finally, some limitations on your investment options apply to money in an IRA. For example, you can't invest in a business you own or in collectibles like gems, jewelry or artwork.

Using a taxable account allows you to invest in any legal investment, including your own business, a house you're going to live in, or collectibles. You can also cash out your investments any time you want without worrying about penalties. Finally, your investment might be taxed at the lower capital-gains rate if you hold your investments for more than one year, whereas IRA distributions are always taxed as ordinary income.

Using a taxable account for your investments does have its downsides. Most importantly, you don't get to shelter your investment from taxes while it's in the taxable account. This means that each time you sell a stock, you'll have to pay taxes on the profits, which can slow the rate at which your account value grows.