First, the individual may be a prime candidate for the backdoor Roth conversion — the initial step of which is the non-deductible IRA contribution. The second reason someone may be inclined to make non-deductible IRA contributions is that any growth or income that accrues inside the IRA after the contribution is tax-deferred and only taxed whenever distributions begin in the future.
Given the potential benefit of deferred taxation, non-deductible IRA contribution may seem to be an underutilized opportunity. However, there are a number of potential drawbacks that tend to make these contributions only useful for short-term traders. In many cases, simply buying an index fund in a regular brokerage account can be far more tax efficient than buying the same fund in a non-deductible IRA.
Otherwise, the premise that the non-deductible IRA will save taxes over the long-run may be ill-conceived. Even if you had not needed to liquidate the IRA account in the example above, the IRS would have forced you to start taking mandatory distributions beginning at age 72 for folks born after June 30, , and every year thereafter. Each of these distributions would again be taxable as the less favorable ordinary income rates.
In contrast, the regular brokerage account imposes no forced distributions so investments can be left to grow tax deferred until the funds are needed. Continue with the same example and assume that you never needed to use the proceeds from the hypothetical investment account. Once it exceeds a certain point, they can deduct only a portion of the contributions they make until their income reaches a top limit.
The IRS sets these levels each year. To simplify, we summarize the rules based on who has a workplace retirement plan below. When income exceeds the first number, only a portion of contributions can be tax deductible. Answer: the backdoor Roth. To figure out your tax liability, take your after-tax contributions and divide them by the total value of all your IRAs. A taxable brokerage account is a completely flexible way to invest for any goal. There are no contribution limits, withdrawal rules, mandatory distributions A Roth IRA is funded with after-tax dollars, just like a non-deducible contribution.
But there are income limits on who can make contributions. For taxpayers who earn too much, consider a backdoor Roth or Roth conversion strategy instead. In a Roth conversion, pre-tax IRA dollars are taxable income for the year, which converts the money into Roth dollars. Again, the pro rata rule applies, so it's often most advantageous to consider a Roth conversion when rolling over an old k. In a Roth k , employees contribute after-tax dollars to a designated Roth account within the k plan.
The annual contribution limit is tied to the k additions limit - much higher than the IRA limit. Once the money is in a Roth IRA, it's tax-free when taken out if you meet the holding period and age requirements. This strategy only works if you don't have any other traditional IRAs. Otherwise, the pro rata rule applies. In a mega backdoor Roth , you max out individual additions to your k then make after-tax non-Roth contributions up to the annual maximum combined employee and employer.
Not all employer plans allow this and there are other considerations to keep in mind before implementing this or any of the other strategies in this article. In our view: probably not. Due to the ongoing recordkeeping and tax reporting requirements, pro rata rule, and other complexities, non-deductible IRA contributions usually aren't worth it. Many people who are not eligible to fully fund a deductible IRA or Roth IRA often overlook this easy opportunity to sock away additional dollars for retirement where they can grow tax-free.
And unlike a k or other salary deferral plan, you can make contributions up through the April 15 tax filing deadline. Unlike a traditional IRA , which is tax-deductible, non-deductible IRA contributions are made with after-tax dollars and provide no immediate tax benefit.
In a given tax year, as long as you or your spouse have enough earned or self-employment income, you can each contribute to an IRA. On March 17, , the Internal Revenue Service IRS announced that the federal income tax filing due date for all taxpayers for the tax year will be automatically extended from April 15, , to May 17, This pushes other tax-related deadlines back as well; for example, the deadline to make IRA contributions is usually April 15, but taxpayers will have extra time this year.
Taxpayers impacted by the winter storms in Texas will have until June 15, , to file various individual and business tax returns, make tax payments, and make IRA contributions. The IRS's extension for victims of the winter storms was announced on Feb. Beginning with the year in which you reach age 72, you must begin taking required minimum distributions RMDs from your IRA. This is no longer the case and you can continue making contributions at any age, so long as you meet the IRS criteria.
Contributions can be allocated across different kinds of IRAs. For example, you could make additions to a tax-deductible, non-deductible, or Roth IRA in a given tax year, as long as the combined contributions do not exceed the limit. Your ability to fund different kinds of IRAs is subject to restrictions based on your income, tax filing status, and eligibility to participate in an employer-sponsored retirement plan , even if no contributions have been made to the plan in a given tax year.
If you and your spouse do not have an employer plan at work, there are no restrictions on fully funding a deductible IRA. However, if either you or your spouse is eligible to participate in an employer-sponsored plan, then the following limits apply in For any year in which you do make a contribution to a non-deductible IRA, you need to include IRS Form in your federal tax return.
This form documents your after-tax contribution, which is important once you begin taking distributions. Once you reach age 72, the IRS requires you to aggregate the value of all your deductible and non-deductible IRAs and begin taking distributions from your traditional but not Roth IRAs. If you made non-deductible contributions, then any distribution contains both a taxable and a nontaxable portion.
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