Individual Retirement Accounts (IRAs) come in many varieties. 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.
What is a non-deductible IRA?
A non-deductible IRA is a retirement plan that’s funded with after-tax dollars. Contributions can’t be deducted from the account holder’s taxable income, as with a traditional IRA. However, contributions can grow, tax-free until retirement.
What are the benefits of a non-deductible IRA?
Non-deductible IRAs are commonly chosen by people who are disqualified from making contributions to a Roth IRA because their income is larger than the established limit. For these taxpayers who still want to make contributions to an account with tax-free withdrawals in retirement, a non-deductible IRA can be the perfect choice.
Backdoor Roth conversions
Non-deductible IRAs are commonly used as a gateway to qualify for Roth IRAs.
Individuals who earn too much to qualify for a Roth IRA can contribute the overage to a non-deductible IRA, and then convert the account to a Roth. Sounds shady? It’s actually completely legal!
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, and you want to convert your non-deductible IRA to a Roth, you’ll pay income tax on some funds.
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 also important to remember that you’ll need to pay taxes on distributions taken during retirement.
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 growth opportunity. It’s also a good idea to review 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.
Love the idea of an IRA with tax-free distributions? The non-deductible IRA may be for you!
