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.

Anyone can make contributions to a nondeductible IRA so long as they have earned income. But just because you can, doesn’t mean you should choose a nondeductible IRA over other retirement saving options.

Since nondeductible IRAs don’t offer the same tax benefits as other plans, you typically should only choose a nondeductible IRA if you don’t qualify for other retirement accounts.

You may also want to contribute to a nondeductible IRA if you hit your annual limit for contributions to your 401(k) or similar employer plan. The IRS adjusts the limit annually. It is $23,000 in contributions for 2024.

If you have access to an employer plan, then your eligibility to contribute to a nondeductible IRA will phase out if your modified adjusted gross income (MAGI) reaches certain levels. These limits depend on your filing status and access to a workplace plan.

If you are covered by an employer plan, and your income is below the ranges listed for the different filing statuses below, you are eligible for a full deduction. If it’s within the range, you qualify for a partial deduction. If it’s above the range, you do not qualify for a deduction.

Suppose you don’t have a retirement plan from your employer. In that case, you can fully deduct the amount you contribute to your traditional IRA, irrespective of your income. However, the deductible also depends on whether your spouse has a retirement plan.

To determine your eligibility, you can use the IRA Worksheet in the IRS Form 1040 instructions.

As with any retirement plan, there are pros and cons to nondeductible IRAs.

For instance, nondeductible IRAs can be an option for people who may not qualify for more traditional retirement savings plans. But they also require that you do much of the record keeping yourself.

Nondeductible IRAs are subject to the same contribution limits as other IRAs.

The contribution limit for a nondeductible IRA is $7,000 in 2024. If you are 50 or older, you can make an additional catch-up contribution of key=”retirement_ira_current_catch_up”]. You and your spouse can each contribute to an IRA if you both are eligible to contribute to a nondeductible IRA.

You can also make contributions to different types of IRAs — nondeductible, tax deductible or Roth IRA — in the same year. But the combined total of your contributions cannot exceed that $7,000 — and $1,000 catch-up limit if you qualify.

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 its phase-out range. 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 $7,000 a year — or an extra $1,000 a year for people ages 50 and up. You can also deduct contributions from your yearly taxes.

However, if you or your spouse have 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.

Check your phase-out range based on you income and filing status to determine whether making nondeductible IRA contributions may be a good option.

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.

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.