There are a lot of ways to make non-deductible IRA contributions. You can contribute to an employer sponsored retirement plan like a 401(k), SEP or SIMPLE IRA, and then convert your traditional IRA into a Roth if the conversion seems like a good idea. When you do this, you’ll likely have to pay taxes on any nondeductible amounts (or, as they’re called in tax lingo, after-tax contributions). But there’s another way: “Nondeductible” means that whatever amount that’s contributed won’t be deductible on your tax return until after 2019 (and even then only up to $5,000).
Contributing to an IRA
- The maximum contribution for any one person is $6,000 in 2019 and $5,000 in 2020 and 2021.* Contributions are made with after-tax dollars.* Contributions are not tax deductible.* For example: you earn $30k/year but pay 32% of everything you earn as taxes; so instead of paying $12k/year in taxes on your income, you only pay 12K – 32% = 8K = 8K x 2 = 16K total annual contributions made by yourself = 16K / 2 years = 10K each year
To contribute to an IRA, you will need to have earned income. You can make a contribution even if your adjusted gross income (AGI) falls below the limit for 2018 and 2019.
Converting to a Roth IRA
The best way to avoid paying taxes on your conversion is to do it before you reach age 70½. If you were born between January 1 and December 31, 1954, and are at least 59 years old as of December 31 of this year (2018), then your traditional IRA is already a Roth IRA. If so, then there’s no need for any further action here; just go ahead and make a withdrawal from your account once per year without worrying about whether or not it will be taxable (note: if you have multiple IRAs with different custodians or financial institutions that don’t report all withdrawals at once then this rule may not apply).
If however your account isn’t yet fully funded or has been set up differently than most people expect–for example if one spouse has contributed more money than the other–then converting some money into a Roth IRA can help ensure that both parties see equal shares upon distribution at retirement.
Distributions from IRAs
If you have an IRA, you may be able to make non-deductible contributions. However, this is not the case for all accounts.
Withdrawals from your retirement account are taxed as ordinary income in the year that they are withdrawn and any subsequent years until they are recontributed into another eligible retirement plan or invested in taxable investment options like mutual funds or stocks. When making withdrawals from traditional IRAs (or 401(k)s), there is no tax due on amounts distributed up to $10,000 per year ($5,500 if single). If you have earned income over these limits but still decide to take money out of your traditional IRA each year before age 59 ½ then those earnings will be taxed at a rate equal to Medicare Part B premiums plus 2% (.02 x W2 wages + 2% = $1.00 x W2 wages).
Nondeductible contributions and their tax implications
Non-deductible contributions are made to your IRA, but they won’t be included in your income. This means that you don’t have to pay taxes on the money when it’s withdrawn from the account. However, if you withdraw this money before age 59½, then it will be taxed as ordinary income (as opposed to being taxed at a lower rate).
When you make nondeductible contributions (and therefore avoid paying taxes on them), there are two ways in which they can affect your tax liability:
- Calculate how much of your contribution is taxable based on how much interest earned by your IRA during the year. The total amount that’s taxable equals 100% x (amount of interest earned / total number).
- Deduct an amount equal to 100% x ($100 – $0) = $100 from both lines above before computing what percentage each line represents based upon its original value ($100/$1000)
It’s important to understand how the various rules work together when making non-deductible IRA contributions.
It’s important to understand how the various rules work together when making non-deductible IRA contributions. As a general rule, your non-deductible IRA contributions are not taxed twice—once when you make them and once when they’re distributed. However, there are exceptions in some cases where you can be taxed twice:
- You must pay taxes on your nondeductible contribution at both the time of deposit and any later time when it’s withdrawn from an individual retirement account (IRA). This applies even if you don’t claim it as an itemized deduction on your tax return because all distributions from IRAs are subject to ordinary income tax rates instead of capital gains rates.
- If part of a distribution is nontaxable due to IRC §72(b)(2)(A) or 72(b)(3), then other amounts will still be taxable according to their category under Section 72(a)(2), which includes anything held in excess of five years (or six years if held by married couples filing jointly).
The key takeaway here is that you have to know the tax implications of your IRA contributions. It’s important to understand the rules, so that you can make informed decisions about whether or not it’s worth paying taxes on them.