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All you need to know about non-deductible IRAs.

Individual Retirement Accounts (IRAs) are the building blocks of retirement planning. Their basic structure and tax advantages make them a popular choice for retirees from every financial bracket.

IRAs come in many varieties and flavors. One lesser-known type is a non-deductible IRA. Let’s take a closer look at this IRA, how it’s structured, and what you need to know about managing it effectively.  
 

5 Things to Know About Nondeductible IRAs

  1. Non-deductible IRAs are designed for contributions that do not qualify as deductibles.
  2. Earnings grow tax-deferred.**
  3. Withdrawals of principal contributions are not taxed.
  4. Contributions are made with after-tax funds and are not deductible.
  5. Earnings are taxed upon withdrawal.

What is a non-deductible IRA?

A non-deductible IRA is a retirement plan that is funded with after-tax dollars. Because of this, contributions to it cannot be deducted from the account holder’s taxable income. However, contributions can grow tax-free until retirement.
 

What are the benefits of a non-deductible IRA?

Non-deductible IRAs are most commonly chosen by people who are disqualified from making contributions to a Roth IRA. In 2024, taxpayers must have a Modified Adjusted Gross Income (MAGI) of $240,000 to contribute to a Roth IRA if filing jointly, and a MAGI of $161,000 or less if filing as a single taxpayer.

For taxpayers who exceed these limits, but still want to make contributions to an account with tax-free withdrawals during retirement, a non-deductible IRA can be the perfect solution. 

 

Backdoor Roth conversions

Non-deductible IRAs are commonly used as a gateway to qualify for Roth IRAs. As mentioned, Roth IRAs have income limits. Individuals who earn too much to qualify for a Roth IRA can contribute the overage amount to a non-deductible IRA, and then convert the account to a Roth IRA. While this may sound shady, it’s a completely legal way to qualify for a Roth IRA. 

It’s important to note, though, that the backdoor IRA may not be 100% tax-free. If you’ve made both deductible and non-deductible contributions to IRAs over many years and you want to convert your non-deductible IRA to a Roth, you’d have to pay income tax on some of these funds. To determine your tax liability in this case, divide your after-tax contributions by the total value of all your IRAs. The percentage you’ll get represents your after-tax contributions. You don’t have to pay federal taxes on this percentage when you start taking deductions. 

 

Factors to consider before opening a non-deductible IRA.

Having a non-deductible IRA long-term does carry some risks. For one, you may need to pay additional taxes if you don’t separate your deductible and non-deductible contributions. It’s best to fill out a Form 8606 for each tax year in which you make after-tax contributions to a non-deductible IRA. This way, you’ll have a clear record of your contributions so the government can easily calculate your taxes when you retire. 

It’s also important to remember that you’ll need to pay taxes on distributions taken during retirement. If you anticipate being in a higher tax bracket when you retire compared to now, a non-deductible IRA may not be the best choice for you. 

 

How can I manage my non-deductible IRA effectively? 

Like any retirement account, you’ll want to maximize your contributions to a non-deductible IRA to ensure you give your retirement money its best chance at growth. It’s also a good idea to take stock of your non-deductible IRA every so often to ensure it’s still the best choice for your current financial circumstances. Finally, be sure to track your pre- and after-tax contributions to your IRA.
 

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