If you don’t get a tax break for putting money into an individual retirement account (IRA), does it make sense to do so?
Many people who aren’t qualified to fully fund an IRA or Roth IRA miss out on this easy way to save more money for retirement that will grow tax-free. And unlike a 401(k) or another salary-deferral plan, you can put money into a nondeductible IRA right up until the deadline for filing your taxes.
Even though a non-deductible IRA doesn’t have all of the tax benefits of a standard or Roth IRA, it still lets you save more for retirement, even if you make too much.
Non-deductible gifts have rules about who can make them and how much they can give.
Savers must keep track of how much they put into non-deductible plans so that they can pay the right amount of taxes when they take money out.
The Non-Deductible IRA: What You Need to Know
Who can get a non-deductible IRA?
Depending on how much money you make and how you file your taxes, you may not be able to put money into certain types of IRAs. It also depends on whether or not you can join a retirement plan offered by your workplace, even if you haven’t put any money into that plan in a given tax year.
If neither you nor your partner has a workplace plan, you can put as much money as you want into a qualified IRA.
But if you or your partner are qualified to join a plan offered by your job, the following limits will apply in 2022 and 2023:
If you file as a single or head of household, your qualifying for a deferred IRA will end between $73,000 and $83,000 of adjusted gross income (MAGI) in 2023.
If you are married and file your taxes together, the phaseout for an exempted IRA is between $116,000 and $136,000 of your MAGI in 2023.
If you file as a single or head of household, your eligibility for a Roth IRA ends between $138,000 and $153,000 of MAGI in 2023.
If you are married and file your taxes together, the limit for a Roth IRA in 2023 is between $218,000 and $228,000 of your MAGI.
In the directions for IRS Form 1040, there is a form called “IRA Deduction Worksheet” that can help you figure out if you are eligible.
Distributions from an IRA that is not tax-deductible
If you put money into a nondeductible IRA, you need to fill out IRS Form 8606 and send it with your federal tax return.
Between the ages of 59 12 and 73, you can take any amount out of your IRA without being charged a fee, but you don’t have to. When you turn 73, the IRS makes you add up the value of all your deductible and non-deductible IRAs and start taking money out of your standard IRAs, but not your Roth IRAs.
If you turned 72 before January 1, 2023, you would have had to start taking required minimum withdrawals (RMDs) from your IRA in the year you turned 72. If you turn 72 after December 31, 2022, however, you don’t have to start taking RMDs until you turn 73.
If you made gifts that were not tax-deductible, any payout you get will have both taxable and nontaxable parts. The part that isn’t taxed is based on how much you put in after taxes, and the part that is taxed is based on how much money those payments are made over time. For example, say you put $50,000 into a non-deductible IRA over the years. By the time you were 73, the account was worth $75,000. About 33% ($25,000) of the account’s value would have grown and be subject to tax.
Based on your age, an IRS table tells you how much your RMD will be. Your IRA manager may give you a statement telling you how much you need to take out, but this is best done by a tax expert, who can also help you figure out how much of your RMD is taxed if it includes non-deductible donations. Also, it’s important to keep track of what you give.
The amount of what is taxed and what isn’t has to be adjusted every year based on the value of all your IRA accounts on December 31.
Investors who have more than one IRA account can take the payout from any one of them or from all of them.
What’s good and bad about a non-deductible IRA?
You can save more for retirement if you open a non-deductible IRA, even if your income makes it hard for you to put money into another kind of IRA. The better off you’ll be in retirement, the more you save and the earlier you start, so save as much as you can.
One big problem with non-deductible IRAs is that you have to keep more records. It is up to you to keep track of and claim any donations that are not tax-deductible. The IRS says that you should keep your 1040 and 8606 forms, as well as the Form 5498 that you get each year from the person in charge of your IRA, to show how much you put in and how much you took out.
This is important so that the cost base doesn’t get lost when the IRA owner dies and goes to the spouse or heir.
Is a Roth IRA the same as a non-deductible IRA?
A non-deductible IRA is treated differently than a Roth IRA. In both types of accounts, money that has already been taxed is put in. On the money you put in the account, you pay the income tax for that year.
But a Roth IRA has a big advantage: when you take the money out, generally after you retire, you won’t have to pay more taxes on either the money you put in or the money you made.
In a non-deductible IRA, on the other hand, your earnings from the money you put in will be taxed when you take it out.
Even so, a high-income worker who has maxed out other ways to save for retirement, like a 401(k), should choose a non-deductible IRA. The money in the account won’t be charged until it’s taken out, so the amount has a lot of time to grow.
Do Required Minimum Distributions (RMDs) apply to a non-deductible IRA?
Yes. RMDs are the same for a non-deductible IRA as for any other IRA. At age 73, you have to start taking out a certain amount every year. How much you have to take out each year depends on your age and other things.
How much can I put into an IRA that I can’t deduct?
Traditional IRAs and non-deductible IRAs have the same limits on how much you can put into them. For 2023, the most you can put into your 401(k) is $6,500, and if you are 50 or older, you can put in an extra $1,000.
Every year, these numbers are changed.
If you make too much money to put money into a standard or Roth IRA, you may still be able to put money into a nondeductible IRA. This kind of IRA is taxed in a different way than other IRAs.
The amount you can put into a non-deductible IRA each year is limited, but it can add up over time. For example, if you started contributing $6,500 a year at age 50 and retired at age 60, assuming a 6% rate of return, your payments could grow to more than $150,000 by the time you were 70. In this case, when you start getting your money back, about 44% of it will be a tax-free return of what you put in.