Contributing to your IRA is a no-brainer. We all know how instrumental it is in saving for the future. But did you know that a non-deductible IRA is one of the best retirement accounts you could start contributing to? In this article, we’ll explain what non-deductible IRA contributions are, why they are worth considering, and if they are right for you. Let’s get started!

What Are Non-Deductible IRA Contributions?

A non-deductible IRA is a type of individual retirement account (IRA) that allows you to make contributions that are not deductible on your federal income tax return.

In other words, you can contribute more money to a non-deductible IRA than you would be able to contribute to a traditional deductible IRA or Roth IRA because you are not able to take a deduction for the contribution when you file your taxes each year. In exchange for this sacrifice, however, your growth and earnings inside the account can grow tax-free.

What Are the Benefits of a Non-Deductible IRA?

So, what are the advantages of a non-deductible IRA? Here are some of the top reasons why people choose this type of account over a traditional or Roth IRA:

  • You want to save for retirement without reducing your current income. If your income is too high for you to deduct any of your contributions from your taxes, then having an account with no tax advantages won’t matter as much as getting started on saving for retirement right away.
  • You want to take advantage of tax-free growth and withdrawals while avoiding penalties on early withdrawals. Since there are no tax advantages associated with having an account with no deductions, there is nothing stopping you from withdrawing money from the account at any time without paying any penalties. 
  • You can use the account as a savings vehicle for other goals besides retirement. For example, if you are saving money for a down payment on a house or planning on paying for college expenses, opening up a non-deductible IRA might help you reach those goals sooner than expected due to its tax advantages.
  • You can still take advantage of tax credits and deductions if they apply to your situation. If you qualify for certain tax credits or deductions that are not connected with your employment such as childcare expenses or medical costs, then these credits and deductions may still apply to your IRA contributions even though they are made with after-tax dollars. You will just have to wait until retirement age before taking advantage.

What Are the Eligibility Requirements of a Non-Deductible IRA?

There are certain eligibility requirements that must be met to make non-deductible IRA contributions. Anyone who makes money can open an IRA, but not everyone is eligible to make non-deductible contributions.

To make a non-deductible contribution, you must meet the following criteria:

  • You must have earned income from employment or self-employment during the year. 
  • You must be under age 70 ½ and not have reached that age by the end of the tax year.
  • Your modified adjusted gross income (MAGI) cannot exceed $78,000 if you’re single or $125,000 if you are married and filing jointly.
  • You cannot be an active participant in a workplace retirement plan through your job or through self-employment.

If you don’t meet any of these criteria, you can’t contribute to a non-deductible IRA.

Other Rules Associated With a Non-Deductible IRA

Once you know your tax filing status, the rules for contributing to a non-deductible IRA are similar to those of a traditional IRA, but there are some differences. You can contribute up to $6,000 annually, or $7,000 if you are 50 or older. But the contributions are not deductible on your tax return.

There are also other rules associated with these accounts. For example, you cannot convert a traditional IRA into a Roth IRA if you have made non-deductible contributions to the account. When it comes time for tax season, you don’t even have to report your non-deductible contributions on your tax return. They just sit in their own little corner of your financial life, waiting for retirement day when they can be used toward your future expenses.

You can’t deduct the amount of your contribution on your income tax return, but you can take advantage of tax-deferred growth and tax-free withdrawals when you reach age 59½. You must make contributions before April 15th of each year to have that year’s contribution count toward the maximum limit. After age 70½, you may need to take required minimum distributions (RMDs) from your account every year.

How Do I Open a Non-Deductible IRA?

You can open an IRA with most brokers and financial institutions, including banks, credit unions, and investment companies like Vanguard and Fidelity Investments. The process for opening an account depends on which institution you choose—some offer online applications only while others may require paper forms or visits to their offices to complete the process.

What is the Difference Between a Non-Deductible IRA and a Roth IRA?

While there are many differences between non-deductible IRAs and Roth IRAs, the most important difference is that with a non-deductible IRA, you get no tax benefit when you contribute to the account. You will pay income tax on that money when it comes out in retirement, but you won’t get any sort of upfront tax break. 

With a Roth IRA, your contributions are after-tax dollars, you pay income tax on the income limited money before putting it into your account. But when you withdraw money from a Roth IRA, you don’t have to pay any taxes on it (provided you have had the account for at least five years).

With either option, you can change your mind at any time and take money out or put more in—but if you are younger than 59½, there may be some penalties involved.

A non-deductible IRA has some benefits over a Roth IRA. For example, it allows for contributions if you make too much money. A non-deductible IRA doesn’t require income limits like the Roth does, as well as allows for partial withdrawals without penalty before age 59½.

Alternative to Making a Non-Deductible IRA Contribution

When you make a non-deductible IRA contribution, you are making an investment in your future. The money you contribute to a non-deductible IRA won’t be tax-deductible, which means that it won’t lower your taxable income for the year. When you withdraw from your account in retirement, you will be able to take it out without paying taxes on it.

However, if you can’t take advantage of the benefits offered by a non-deductible IRA, there are several options to help you save for retirement after tax dollars: 

Roth IRA

A Roth IRA is an individual retirement account that allows for tax-free withdrawals of your contributions in retirement, but no tax deduction for your contributions. This means that if you make the maximum contribution to your Roth IRA each year, you will be able to withdraw those funds at any time without owing taxes on them. 

However, if you have made any non-qualified withdrawals from the account (i.e., withdrawals that don’t meet the requirements for qualified distributions), then those amounts will be subject to ordinary income tax plus a 10 percent penalty fee if they are taken before age 59½.

The maximum amount you can contribute if you are under age 50 is $6,000 per year. If you are over age 50, the maximum amount is $7,000 per year. If you contribute more than these amounts, any excess will be considered an excess contribution and will be subject to a 6 percent penalty tax.

Roth Conversion

Converting a non-deductible IRA to a Roth IRA is a great way to save for retirement. You can convert your traditional IRA into a Roth IRA at any time, but if you have funds in a non-deductible IRA, you will need to take some extra steps before you can convert.

Here’s what you need to know about converting a non-deductible IRA to a Roth IRA:

Converting a non-deductible IRA to a Roth IRA is simple: you take money from your traditional IRA, pay tax on it, then deposit it into your Roth IRA account. The amount you convert is added to your taxable income for the year, so you will owe taxes on that money unless you meet the income limitations discussed below.

To convert your traditional IRA into a Roth IRA, the account must have been open for at least five years and be worth more than its original value when converted. If you’re married, filing jointly, and either spouse meets these requirements, both of your IRAs can be converted at once. If one spouse doesn’t meet those requirements, he or she can convert his or her own account independently of the other spouse’s conversion plan.

You must pay taxes on the money converted. This means that if you convert $10,000 and it’s all earned income, you will pay income tax on $10,000. If some of it is from funds in your 401(k), or other sources that aren’t taxable until withdrawn, then only the portion that is taxable will be subject to tax at conversion.

The conversion amount will be taxed as ordinary income in the year of conversion. If you take distributions from your IRA to fund the conversion, those distributions will also be taxed as ordinary income in the year of distribution (rather than capital gains). For example, if you have $10,000 in earnings for this year and want to convert it all into a Roth now so you don’t have to pay taxes next year on those earnings when they’re withdrawn from your traditional IRA account, you will pay ordinary income tax on $10,000 this year (and possibly some alternative minimum tax too if your income makes AMT applicable).

A Roth 401(K)

If you are not eligible to make a non-deductible IRA contribution, you may still be able to make an IRA contribution by using a Roth 401(k).

A Roth 401(k) is like a traditional 401(k), but instead of taking a tax deduction for your contributions, you don’t pay taxes on the money you withdraw after retirement.

You can contribute up to $19,000 per year to your Roth 401(k). If you’re age 50 or older, the contribution limit increases to $25,000.

Unlike a traditional IRA, you can’t deduct your contributions from your taxable income. But if you are in the 15 percent tax bracket or lower, it may be worth considering this type of account over making a non-deductible IRA contribution.

Backdoor and Mega Backdoor Roth

Although it may sound counterintuitive, you can make a non-deductible IRA contribution to your account and still get the tax benefits of making a non-deductible IRA contribution. How? By using either the Backdoor or Mega Backdoor Roth IRA strategies.

The term backdoor refers to the fact that you contribute after-tax dollars to your traditional IRA, which allows you to receive the tax deduction for your contribution. The money grows tax-free until you withdraw it in retirement.

A mega backdoor Roth IRA is similar to a regular backdoor Roth IRA in that it allows you to contribute after-tax dollars into an existing account. The difference between the two is that with a mega backdoor Roth IRA strategy, there are no income restrictions on making direct contributions into an existing traditional IRA account.

Things to Consider Before Using a Non-Deductible IRA

If you’re considering a non-deductible IRA contribution, there are a few things you should keep in mind.

First, if you have a traditional IRA, you may be able to contribute more dollars using a non-deductible IRA than you can using a traditional IRA. This is because non-deductible contributions aren’t counted towards the annual maximum for your IRA contributions.

Second, if your income is too high to qualify for making a deductible contribution, consider making a non-deductible contribution instead. You will still get to save and invest in your future, but you won’t have to pay taxes on the money until it is withdrawn in retirement (when it will likely be taxed at a lower rate).

And finally, keep in mind that while making non-deductible contributions might not give you any tax benefits upfront, it will help reduce your taxable income—and thus your tax liability—in the future.

Final Thoughts On Non-Deductible IRAs

Non-deductible IRA contributions are a fantastic way to start saving towards your retirement, even if you are also taking advantage of tax savings elsewhere. They are flexible, easy to establish, and can be extremely useful to you down the road.

Looking for more helpful investment advice? Explore more financial resources and tools on our website.

About the Author Tiffany Aliche

Tiffany “The Budgetnista” Aliche, is an award-winning teacher of financial education, America’s favorite, personal financial educator, and author of the New York Times Bestselling book, Get Good with Money. The Budgetnista is also an Amazon #1 bestselling author of The One Week Budget and the Live Richer Challenge series and most recently, a children's book, Happy Birthday Mali More.

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