The Advantages of Adding to a Traditional IRA if Non-Deductible

by Mark Kennan

Though you might be disappointed if you find out you cannot claim an income tax deduction for contributions you make to your traditional IRA, you should consider the advantages of making non-deductible contribution before deciding against a contribution altogether. In some cases, a non-deductible contribution provides significant retirement savings benefits.

Tax-Deferred Growth

Even if you cannot deduct your traditional IRA contribution, you can take advantage of the tax-deferred growth offered by traditional IRAs. As long as the non-deductible contributions remain in your traditional IRA, you do not have to pay income taxes on any gains on that money. If you save your money in an account that isn't tax sheltered instead of in a traditional IRA, part of your earnings are be eaten away each year by income taxes.

Tax-Free Distributions of Contributions

When you take a distribution from a traditional IRA containing non-deductible contributions, you get to withdraw the non-deductible contributions without having to pay income taxes. Your distributions are divided between non-taxable parts and taxable parts, based on the portions in your account. This is especially beneficial if you expect to be paying a higher income tax rate when you take money out of your traditional IRA than in the year you put the money in.

Smaller Taxable Amount for Roth Conversions

If you would prefer to save money in a Roth IRA but you don't qualify because your income is too high, you can make non-deductible contributions to a traditional IRA and then convert it to a Roth IRA. If you make a non-deductible contribution to the traditional IRA, that portion of the conversion does not add to your taxable income when you make the conversion to the Roth IRA.

Why a Contribution Is Non-Deductible

Anyone can make non-deductible contributions to a traditional IRA for any reason. However, the IRS also sets limits on your modified adjusted gross income for the year if you want to deduct your traditional IRA contribution and if you or your spouse could contribute to an employer-sponsored retirement plan. These limits vary each year and differ depend on your tax filing status. When you make a non-deductible contribution, make sure you report it on your income taxes using Form 8606, Part I.

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