Nondeductible IRA

A nondeductible IRA is just a traditional IRA funded by nondeductible contributions. But unlike a traditional IRA, nondeductible contributions come out tax-free in retirement. High income earners often use a nondeductible IRA as a steppingstone to a Roth IRA.

What Is a Nondeductible IRA?

A nondeductible IRA is a way for high income earners to save additional money for retirement.

There are no income limits on who can make nondeductible IRA contributions.

While you can’t deduct these contributions to lower your yearly tax bill like you can with a traditional IRA or a 401(k) plan, a nondeductible IRA offers some attractive tax advantages when you start withdrawing money during retirement.

First, any investment gains made within the account are tax deferred, so you won’t owe tax on this part of your account until you start making withdrawals after the age of 59.5.

But unlike a traditional IRA, any money you originally contributed to the account comes out tax-free because you didn’t take a deduction when you put it in.

Let’s say you made $50,000 worth of nondeductible contributions to a traditional IRA in the decade before retirement. Over a 10-year period, your investments grew by $8,000. Your total account balance is now $58,000.

You’ll eventually owe taxes on the $8,000 in gains, but not on your original $50,000 in contributions.

You must use IRS Form 8606 to report nondeductible contributions made to traditional IRAs.

Is a Nondeductible IRA Right for You?

A nondeductible IRA makes the most sense for people who are unable to enjoy the tax advantages of other individual retirement accounts because of income, filing status or eligibility requirements.

For example, you cannot contribute to a Roth IRA if your modified adjusted gross income exceeds $140,000 as a single filer or $208,000 as a married filer in 2021.

With that option eliminated, you may consider a traditional IRA.

If neither you nor your spouse has access to a retirement account at work, you are free to open a traditional IRA.

You’ll be able to contribute the maximum $6,000 a year — or $7,000 a year for people age 50 and up. You can also deduct contributions from your yearly taxes.

However, if you or your spouse has access to a 401(k) plan or similar employer-sponsored account and you earn too much to contribute to a Roth IRA, you also earn too much to deduct contributions to a traditional IRA.

To summarize:
  • If you have access to a workplace retirement plan and have a modified adjusted gross income higher than $76,000 in 2021 as a single filer — or more than $125,000 as a married filer — you cannot deduct contributions to a traditional IRA.
  • If your modified adjusted gross income exceeds $140,000 as a single filer in 2021 — or $208,000 as a married filer — you cannot contribute to a Roth IRA.

If either of these situations applies to you, making nondeductible IRA contributions may be a good option.

Converting to a Backdoor IRA

Deferring taxes on your IRA investment gains is nice — but what if you could avoid those taxes completely?

Enter a backdoor IRA.

If your income locks you out of a Roth IRA, you can simply contribute to a nondeductible IRA and then convert to a Roth.

It’s a legal way for high-income earners to reap additional tax benefits.

Roth contributions are made with after-tax dollars. When you convert nondeductible IRA contributions to a Roth, you’re also converting after-tax dollars.

Once the conversation is completed, any investment gains within the account can be withdrawn as a qualified distribution tax free.

How to Perform a Backdoor IRA
  1. Open a new traditional IRA.
  2. Make nondeductible contributions to it.
  3. Convert it into a Roth IRA.

If you want to convert a nondeductible IRA to a Roth IRA, it’s best to do so quickly. Otherwise, the nondeductible contributions inside your IRA can accumulate investment gains — and you’ll owe tax on that growth if you convert to a Roth IRA.

Most brokerages can help you handle a backdoor Roth IRA conversion.

Check with your IRA providers to learn more about specific paperwork and requirements.

Last Modified: February 16, 2021

6 Cited Research Articles

  1. Marquit, M. (2020, December 14). What Is A Backdoor Roth IRA? Retrieved from https://www.forbes.com/advisor/retirement/backdoor-roth-ira/
  2. Internal Revenue Service. (2020, November 16). 2021 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are NOT Covered by a Retirement Plan at Work. Retrieved from https://www.irs.gov/retirement-plans/2021-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-not-covered-by-a-retirement-plan-at-work
  3. Internal Revenue Service. (2020, November 16). 2021 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work. Retrieved from https://www.irs.gov/retirement-plans/2021-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work
  4. Internal Revenue Service. (2020, November 12). IRA FAQs – Contributions. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-contributions
  5. Internal Revenue Service. (2020, November 10). Roth IRAs. Retrieved from https://www.irs.gov/retirement-plans/roth-iras
  6. Internal Revenue Service. (2020, September 23). About Form 8606, Nondeductible IRAs. Retrieved from https://www.irs.gov/forms-pubs/about-form-8606