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Non-Deductible IRA Contributions: What You Need to Know

Monday, May 20, 2013  2 comments

In order to make an IRA contribution, you must be younger than age 70 1/2 for the year and also have wages or compensation from your job. Once you make your IRA contribution, then you have to figure out whether it's tax deductible or not.

non-deductible IRA contribution
If either you or your spouse actively participates in an employer retirement plan at work, then you might not be able to take a tax deduction, depending on your income. If you, or your CPA, determine that you aren’t eligible to take a tax deduction for your IRA contribution, then your IRA contribution is nondeductible.

If you make an IRA contribution that isn’t tax deductible, you must file IRS Form 8606 to report it as nondeductible. You will now have what’s known as “basis” in your IRA (money that isn’t taxable when you later take a withdrawal). Even though you may not get a tax deduction, nondeductible IRA contributions will give you tax-deferred interest just like all of your other IRA money; plus, you are saving more money for your retirement.

When you have basis, you’ll also have to file Form 8606 in any year you take a distribution from any traditional IRA, including SEP and SIMPLE IRAs, to calculate the nontaxable portion of your withdrawal.

If you don’t file Form 8606 to report nondeductible contributions, then there’s a $50 IRS penalty. But worse than that, if you can’t prove you have basis, all of your future IRA distributions will be treated as fully taxable.

Roth IRA contributions are also not tax deductible, but you don’t file Form 8606 to report Roth contributions. If you discover that your IRA contribution isn’t tax deductible, you are better off making a Roth IRA contribution instead. Assuming your income isn’t too high, the Roth IRA funds grow tax-free, not just tax-deferred. The income limits for making a Roth IRA contribution for 2013 are $178,000- $188,000 if you’re married filing jointly or $112,000 - $127,000 if you’re single.

For example, if you’re married filing joint and you and your spouses’ total income is below $178,000, you can make a full Roth IRA contribution of $5,500 (or $6,500 if you’re age 50 or older).

-By Joe Cicchinelli and Jared Trexler

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2 comments:

The IRA can be termed as a private investment which you open and fund with your own money. The IRA plan taken can be the traditional, non-deductible and the Roth IRA.

Ed, pretty interesting. We have a client who was able to deduct their full contribution because they don't participate in any 401k or similar plan.

It was great to know that and share it with others.

We are working with them to fund the financial future quicker. The standard and catch up provisions don't make an IRA very viable.

-- Rick

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Q:
You recently said that a 401(k) distribution would add to your MAGI (modified adjusted gross income) for the purpose of determining if you are subject to the 3.8% healthcare surtax. What about Roth IRA distributions? Would they also count towards your total MAGI income for surtax purposes?

Thanks

A:
IRA distributions are exempt from the 3.8% surtax, but taxable distributions from IRAs can push income over the threshold amount, causing other investment income to be subject to the surtax. Because Roth IRA distributions are generally tax-free, they don’t count towards your total MAGI.

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