Your Guide To Nondeductible IRA Contributions

Making nondeductible individual retirement account (IRA) contributions is a retirement strategy that could help you save more toward your non-working years. Curious about how you can contribute to one and why it’s important? Let’s take a closer look at how this strategy works.

What Is A Nondeductible IRA?

It’s a common misconception that a nondeductible IRA is a type of account (it is not). Instead, an individual can make a nondeductible contribution to a traditional IRA, but without the tax deduction a traditional IRA provides. This allows the individual to take advantage of tax-free growth but without the tax deduction on the front end they might normally expect from a traditional IRA.  

In other words, you won’t deduct contributions from your income taxes when filing with the IRS. On the positive side however, unlike a traditional IRA, you won’t be taxed on the nondeductible portion of your contributions when you withdraw your funds in retirement or after age 59 ½.

Who Is Eligible To Make Nondeductible IRA Contributions?

To make a nondeductible contribution to an IRA, you’d first want to check whether you are eligible to contribute to a Roth IRA, which has income limitations. Depending on your modified adjusted gross income (MAGI), which will never be more than your annual income, you may not be eligible for a Roth IRA which would allow after-tax funds to grow tax-free, and withdrawals would also be tax free.

If you are eligible for a Roth IRA, it may be worth considering using that type of account before making nondeductible contributions to a traditional IRA.

For a traditional IRA, there are no income eligibility requirements to contribute, but whether your contributions are deductible or nondeductible will depend on your income. The higher your income, the less likely you’ll be able to deduct your contributions. Your eligibility to participate in one can also be impacted and influenced by whether you are also eligible to participate in an employer-sponsored retirement plan like a 401(k).

For instance: If you’re a single tax filer or head of household, your ability to place tax-deductible contributions in a traditional IRA depends on your modified adjusted gross income (MAGI). Should it top certain thresholds mandated by the IRS, you’ll only be eligible to deduct a portion of your IRA contributions. Once reached, Any additional contributions will be considered “nondeductible”.

Below are the general guidelines for IRA deductions as of 2023:

Nondeductible IRA Contributions: Rules And Limits

If you’re thinking of making a nondeductible IRA contribution as part of your strategy to save for retirement, it helps to note how important tax-free earnings can be – especially for high-income earners. Bearing this in mind, it helps to think about how nondeductible IRA contributions work in practice.

Withdrawal Limitations

So long as you are 59 ½ to 73 years old, you’re able to take as much out of your traditional or Roth IRA as you like without penalty. Upon reaching age 73, the IRS mandates that you aggregate the total value of all deductible and nondeductible IRAs in your possession, and that you start to take distributions from your traditional IRA accounts. These are called Required Minimum Distributions or RMDs.

There are no RMD requirements for Roth IRAs (another reason to consider using a Roth IRA over making nondeductible contributions to a traditional IRA if you’re eligible to do so).

Maximum Yearly Contribution

The maximum that you can contribute to a nondeductible IRA is $6,500 in 2023 – or $7,500 if you’re age 50 or older.

Distributions Requirement

To keep track of which contributions are deductible vs. which are not (which you’ll want to do to avoid being taxed twice in retirement) you’ll need to file Form 8606 with the IRS for each year that you contributed to your nondeductible IRA. This allows the agency to keep track of your after-tax submissions. Should you wish to start taking money out of your account without penalty, you can do so freely from age 59 ½ to 73. However, when you start taking distributions out of the account in retirement, you will be required to pay taxes on any gains as well as the portion of contributions that may have been tax-deductible previously, which could increase your income tax bracket. Further, after the age of 73, it may be necessary to take RMDs from your IRA accounts.

When A Nondeductible IRA Makes Sense

Investing in a nondeductible IRA makes sense if you’re not eligible to make contributions to a Roth IRA, or tax-deductible contributions to a traditional IRA. This is especially true if you’re a high earner who’s maxed out your other options, such as your 401(k). Depending on your filing status, making nondeductible contributions can help your money grow while investing and avoid capital gains tax on a portion of your income in retirement.

Pros And Cons Of Nondeductible IRA contributions

There are both upsides and downsides to consider when debating to nondeductible IRA contributions.

Nondeductible IRA Contribution FAQs

Below are some frequently asked questions (FAQs) about nondeductible IRA contributions.

Is a Nondeductible IRA a Good Idea?

It can be, especially if you’ve already explored and/or maxed out other tax-advantaged investment vehicles like your 401(k).

What is the Difference Between a Traditional IRA and a Roth IRA?

The difference between a traditional and Roth IRA is that a Roth IRA lets you withdraw your contributions and earnings tax and penalty free in retirement. In other words, rather than helping you simply defer taxes, a Roth IRA helps you avoid taxes on these sums entirely.

The Bottom Line: Nondeductible IRA Contributions May Have A Place In Your Retirement

Nondeductible IRA contributions aren’t a perfect option, but they can help you gain significant tax savings while your investments grow That said, nondeductible contributions also come with drawbacks in the form of additional paperwork and how much money that you can contribute in the course of a year.

Tracking your retirement funds can be complicated, especially if you have multiple accounts. Happily, you (and your financial advisor) can gain complete visibility into your money by signing up for the Rocket Money℠ app today.