Pros and Cons of Non-Deductible Traditional IRA Contributions

By Laura Johnson, EA

Generally, traditional IRA contributions are deductible. However, many taxpayers can’t claim the deduction due to income limits and/or participation in an employer’s retirement plan. That doesn’t bar a contribution, but the contribution will not be deductible. 

Non-deductible traditional IRA contributions can be part of a smart retirement plan. But not always.

Here are some reasons why you should make a non-deductible traditional IRA contribution:

Tax-deferral during the build-up phase

Even though you don’t get a deduction up front for putting the money in, the invested money will not be subject to income tax during the build-up phase. The further away you are from retirement age the more valuable this is. That’s because income and gains can build up in the IRA, free of the drag of tax.

Eyeing a Roth IRA conversion

Those with higher incomes cannot fund Roth IRAs directly. Normally, converting a traditional IRA to a Roth IRA is taxable. However, to the extent your IRA contributions have been non-deductible, a conversion is tax-free. This “back-door” Roth conversion can get you into a Roth IRA when a direct Roth contribution is impossible.

Retirement accounts aren’t where they should be
Perhaps you are late to the retirement game or had a stretch of years when you didn’t contribute. If your retirement account balances aren’t where you would like them to be, this is a way to get caught up

Here are some reasons why non-deductible traditional IRA contributions may not be appropriate: 

Record-keeping

It is simple, but of the absolute importance. If you don’t keep good records, you are going to lose out. Non-deductible traditional IRA contributions are made with post-tax dollars. But by default, distributions from traditional IRAs are taxable. If you don’t keep track of your non-deductible IRA contributions, you will be taxed twice on the same funds!

It is the responsibility of the taxpayer to keep track of non-deductible IRA contributions, which may span many, many years. The IRS will not keep track of this for you. Make sure you keep you good records, and that your tax preparer has that information as well, especially when you start receiving distributions.

Tying up your money until 59 1/2

The money is going into a retirement account which means you won’t be able to access the funds, without penalty, until you are 59 1/2.

At John Schachter + Associates, we help clients plan for retirement using a variety of strategies. Let us know if we can help you today!