A Guide to Non-Deductible IRA Contributions

Couple review the balance in their IRAs
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If your income exceeds specific levels, you may not be able to make tax-deductible contributions to your regular IRA, or the amount of your contribution may be limited. Certain restrictions may affect your ability to deduct your contributions.

But you still can save for your retirement with a non-deductible IRA contribution. Although your non-deductible IRA contributions won't reduce your taxes in the year you make them, you can defer taxes on the earnings on them, the key tax advantage of a regular IRA.

Non-Deductible IRA Contributions Build for the Future

Although you don't receive any immediate tax benefit from a non-deductible IRA contribution, the tax-deferred growth can be significant, and it may ultimately make the contribution worthwhile, especially if you expect to have a lower tax rate after you retire than you do now.

When you take your regular IRA distributions during retirement, you pay taxes on the growth. But any non-deductible contributions are treated as your basis (your sum total). Since you effectively paid tax on the money when you made the contribution, you won’t have to pay tax on it again later. The IRS keeps track of filers who have paid taxes on non-deductible contributions with the mandatory Form 8606.

Let's say you made a $2,000 non-deductible contribution one year ago, and your account balance, through additional deductible contributions and investment growth, was worth $20,000 when you make a withdrawal. If you were to make a $1,000 withdrawal during retirement, only $900 would be considered taxable income, since 10% ($2,000 divided by $20,000) was a return of a non-deductible basis.

It's not always clear whether non-deductible IRA contributions are the best place for you to stash your retirement savings. For example, if you expect your income (and your tax rate) to continue rising, you may want to pay taxes on earnings as you go, rather than defer them.

Income Restrictions

Rules for IRA contributions are complex, and it pays to review them each year. Also, the contribution limits can vary from year to year. For tax years 2019 and 2020:

  • If you're 50 and older, you can put a combined total of $7,000 into your traditional and Roth IRAs
  • If you're 49 and younger, you can put a combined total of $6,000 into your traditional and Roth IRAs

These limits don't apply to rollover contributions or qualified reservist repayments. But you may not be able to deduct everything you contribute to a traditional IRA. If you're employed by a company that offers a workplace retirement account such as a 401(k) or 403(b), you face certain income limits for deducting your IRA contributions. It is true, regardless of whether you choose to participate in the workplace retirement plan.

For tax year 2019, if you're covered by a retirement plan at work, file as single or head of household, and your adjusted gross income is $64,000 or less, you're eligible to take the full deduction. If you're filing as married filing jointly or as a qualified widow(er) and you make $103,000 or less, you're eligible for the full deduction. If you're married filing jointly and your spouse is covered by a workplace plan, but you're not, you can deduct the full amount if you make $193,000 or less.

For tax year 2020, the AGI limits increase slightly for those covered by an employer-sponsored retirement plan. If you're filing as single or head of household, you can claim the full deduction if your AGI is $65,000 or less. If you're married filing jointly or a qualifying widower, you can claim the full deduction if your AGI is $104,000 or less. And if you're married filing separately, you can claim a partial deduction if your AGI is less than $10,000. If you're married filing jointly and your spouse is covered by a retirement plan through work, but you're not, you can take the full deduction if your AGI is $196,000 or less.

Deductions are phased out from there as income rises. If you're married filing separately, you're subject to more stringent income rules, although if you're separated and have lived apart for the entire year, you're treated as a single-payer by the IRS for these limits.

On the other hand, if neither you nor your spouse is eligible to participate in a workplace retirement plan, you may make deductible IRA contributions as long as you (or your spouse) have earned income, regardless of the amount.

Roth IRA as an Alternative

If you have income exceeding the limits for a regular IRA deduction, you may still be eligible for a Roth IRA contribution, which has significantly higher income limits. If this is your situation, it typically makes sense to choose a Roth IRA contribution over a non-deductible IRA. After all, while neither contribution is deductible, with a regular IRA, the contribution grows tax-deferred, but a Roth IRA contribution grows tax-free.

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