Does a non-deductible ira make sense?

You can use a non-deductible IRA to enjoy the growth of a tax-deferred investment if you can't take advantage of the deductibility of a traditional IRA. However, most commonly, higher-income workers access financial advisors' favorite retirement account, the Roth IRA. Your ability to fund different types of IRAs is subject to restrictions based on your income, your tax status, and your eligibility to participate in an employer-sponsored retirement plan, even if no contribution has been made to the plan in a given fiscal year. Any money you contribute to a traditional IRA that you don't deduct on your tax return is a “non-deductible contribution.” Still, you must report these contributions on your tax return, and you must use Form 8606 to do so.

Taxpayers use Form 8606 to declare a series of transactions related to what the Internal Revenue Service (IRS) calls individual retirement agreements and what most people simply call IRAs. Keep in mind that you can still contribute money to an IRA in these situations and that your earnings will continue to increase tax-free. To find the tax-free dollar amount, multiply the tax-free percentage by the total amount of IRA distributions throughout the year. However, there are several important differences between a non-deductible IRA and a traditional or Roth IRA, such as who can contribute and the benefits associated with investing in each of them.

In a clandestine Roth, investors make a non-deductible contribution to a traditional IRA and then quickly convert it to a Roth IRA. The prorated rule applies to distributions from a traditional IRA, SEP or SIMPLE with tax-deductible funds and after-tax funds (non-deductible, not Roth). If you want to contribute to a Roth IRA and your income is too high to do so, using a non-deductible IRA can also allow you to benefit from the favorable tax rules associated with a Roth IRA. From a tax return standpoint, you can simply file a Form 8606 with your next tax return to reflect historical non-deductible contributions to the IRA.

Unlike a traditional IRA, which is tax-deductible, contributions to a non-deductible IRA are made with after-tax money and don't provide any immediate tax benefits. However, if you also have assets in a traditional IRA, part of the converted funds must be included in your taxable income. In a given tax year, as long as you or your spouse have sufficient earned or self-employment income, each of you can contribute to an IRA. However, your contributions to a non-deductible IRA are made with after-tax money, while your contributions to a traditional IRA or 401 (k) can be deducted the year they were made.

The calculation for determining the taxable and non-taxable ratio must be recalculated each year based on the December 31 value of all your IRA accounts. A non-deductible IRA is a retirement savings account to which you contribute money after taxes, but which allows you to increase your retirement money tax-free until the profits are withdrawn.