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When You're Over The Limit - Non Deductible IRA Contributions

If you can't deduct your IRA contributions, you can still save with an IRA.


Many people are not allowed to make a tax-deductible contribution to their regular IRA. If your income exceeds specific levels, certain restrictions apply to you. However, you can still make a non-deductible IRA contribution and save for your retirement. Although your non deductible IRA contributions do not save you taxes in the year you make them, the earnings on them are tax-deferred, a key tax advantage of a regular IRA.

IRA Income Restrictions

If you or your spouse are employed by a company that offers a workplace retirement account, such as a 401(k) or 403(b), you face certain income limits for deducting your IRA contributions. This is true regardless of whether you actually choose to participate in the workplace retirement plan. On the other hand, if neither you nor your spouse is eligible to participate in such a plan, then you may make deductible IRA contributions as long as you (or your spouse) have earned income.

Roth IRA as an Alternative

Many people who have income exceeding the limits for a regular IRA deduction may still be eligible for a Roth IRA contribution, which has higher limits. If so, it typically makes sense to choose a Roth IRA contribution over a non-deductible IRA. After all, while neither contribution is deductible, with a regular IRA the contribution grows tax-deferred but a Roth IRA contribution grows tax-free.

Non-Deductible Contributions Build Basis

When you take your regular IRA distributions during retirement, you’ll pay tax on the growth. However, any non-deductible contributions are considered basis and, since you effectively paid tax on the money when you made the contribution, you won’t have to pay tax on it again later.

Say you had made a $2,000 non-deductible contribution one year long ago and your account balance, through additional deductible contributions and investment growth, was worth $20,000 when you make a withdrawal. If you were to make a $1,000 withdrawal during retirement, only $900 would be considered taxable income since 10% ($2,000 divided by $20,000) was a return of non-deductible basis.

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