When You're Over the IRA Limit: Non Deductible IRA Contributions

You Can Still Save With an IRA

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Many people are not allowed to make tax-deductible contributions to their regular IRA, or the amount of the contribution may be limited. If your income exceeds specific levels, certain restrictions may apply to you that affect your ability to deduct your contributions.

However, you still can save for your retirement with a non-deductible IRA contribution. Although your non deductible IRA contributions will not reduce your taxes in the year you make them, the earnings on them are tax-deferred, a key tax advantage of a regular IRA.

Non-Deductible IRA Contributions Build Basis

It may be discouraging when you don't receive any immediate tax benefit from a non-deductible IRA contribution. But the tax-deferred growth can be significant, and 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. However, any non-deductible contributions are treated as your basis. Since you effectively paid tax on the money when you made the contribution, you won’t have to pay tax on it again later.

For example, say you had 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.

IRA Income Restrictions

Rules for IRA contributions are complex, and it pays to review them each year.

In addition, the contribution limits can vary from year to year. For tax year 2017:

  • Those 50 and older can put a combined total of $6,500 into their traditional and Roth IRAs.
  • Those 49 and younger can put a combined total of $5,500 into their traditional and Roth IRAs.

These limits don't apply to rollover contributions or reservist repayments.

However, you may not be able to deduct everything you contribute to a traditional IRA.

If you are 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. This is true regardless of whether you actually choose to participate in the workplace retirement plan.

For tax year 2017, those covered by a retirement plan at work and filing as single or head of household making $62,000 or less are eligible to take the full deduction, while those filing as married filing jointly or as a qualified widow(er) and making $99,000 or less are eligible for the full deduction. If you are 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 $184,000 or less.

Deductions are phased out from there as income rises.

Those who are married filing separately are subject to more stringent income rules, although anyone who is separated and who lived apart for the entire year is treated as single by the IRS for the purposes of these limits.

On the other hand, if neither you nor your spouse is eligible to participate in a workplace retirement plan, then 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

Many people who have income exceeding the limits for a regular IRA deduction may still be eligible for a Roth IRA contribution, which has significantly higher income limits (see 2017 Roth IRA Income Limits).

If this is the case for you, 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.