What is a nondeductible IRA? Who’s eligible + is it worth it?

Saving for retirement has its perks, like the immediate tax break most investors earn. If your contributions qualify for a tax deduction, your bill shrinks. But when they don’t, your account is known as a nondeductible IRA. 

When your IRA contributions don’t qualify for an immediate tax deduction, it’s  usually because you have an employer-provided account and exceed certain income limits. You can still contribute to your IRA, but contributions aren’t tax deductible.

So, are your IRA contributions deductible? Learn more about IRA deduction guidelines and when nondeductible contributions can work for you.

Nondeductible IRA basics

A nondeductible IRA means exactly what it says — your IRA contributions aren’t eligible for a deduction. 

This technically includes Roth accounts funded with after-tax dollars. So, you pay income taxes as usual, make your IRA contributions, and enjoy tax-free growth. But we’re not really talking about Roth IRAs today. 

Nondeductible IRAs typically refer to nondeductible contributions to a traditional IRA. 

Typically, you contribute pre-tax cash to a traditional IRA and claim the deduction on your tax return. Taxes are deferred until withdrawal, providing a little protection from Uncle Sam. 

But your contributions might not qualify for deductions if you:

• Contribute to an employer-provided plan like a 401(k) or 403(b) 
• Exceed modified-adjusted gross income (MAGI) limits. 

Otherwise, nondeductible IRA rules are the same as your typical IRA, including contribution limits and withdrawal regulations. They’re great for high-income earners that want to save more for retirement than their employer plan permits. 

Nondeductible IRA contribution limits + eligibility

Nondeductible IRA contribution limits are the same as traditional or Roth IRAs:

• 2024 contribution limit: $7,000
• Catch-up contribution (for ages 50+): $1,000

The IRS adjusts these each year to keep up with cost of living increases.

Nondeductible IRA eligibility boils down to whether or not traditional contributions are tax-deductible. And that depends on your modified adjusted gross income (MAGI) and enrollment in employer-provided plans. 

If you or a spouse contribute to a 401(k) and exceed the income limits, you can continue contributions to a traditional IRA, but you won’t be able to take deductions. 

The 2024 income limits for pre-tax deductions are:

If neither you nor your spouse have an employer-provided retirement plan, all of your pre-tax contributions to a traditional account are tax deductible. 

How to file nondeductible contributions

You have to manage your own IRA — it’s one of the major inconveniences to know if you’re comparing an IRA with a 401(k). So, you’re responsible for reporting nondeductible traditional contributions to the IRS. 

Filing is simple — you just have to report your contributions in Part L of Form 8606.

You can also report IRA distributions and Roth conversions using the same form.

Failure to file your nondeductible contributions can trigger additional future taxes. 

Account distributions: Rules, taxes, and potential penalties to know

Nondeductible traditional account distributions get a little complicated — at least compared to other IRAs. 

You’ll have to pay taxes on your contributions upfront. However, you still benefit from deferred taxes on your earnings. You’ll pay these taxes once you withdraw cash from the account. 

Roth accounts actually grow tax-free, so you won’t owe any taxes on earnings. But traditional accounts still charge on your earnings, even if you make after-tax contributions. 

So, how do you know if you’ll pay taxes on your distribution? And how much can you expect to pay?

The account will distribute your taxable and tax-free funds based on the proportion of nondeductible contributions made. So, if 30% of your funds are non-deductible contributions (an amount you already paid income taxes on), your distribution will include 30% tax-free contributions and 70% taxable earnings. 

Required minimum distributions (RMDs)

IRAs also enforce minimum distributions called RMDs once you reach age 73 if you have a traditional account, SEP, or SIMPLE IRA. The minimum distribution is calculated based on your account balance and life expectancy. 

You can always take out more, but failure to meet the minimum could rack up some expensive penalties. 

Nondeductible vs. Roth vs. traditional IRAs

Whether you qualify for the tax deduction or not, you can always choose to make non-deductible contributions to an IRA.  But remember: A nondeductible traditional IRA has different tax treatments than other nondeductible contributions, like those you make to a Roth IRA. 

Here’s an overview of the types of IRAs and their tax treatments:

So, a traditional IRA and Roth IRA charge taxes at one time — either at withdrawal or prior to contribution. 

Traditional accounts charge income taxes on contributions and earnings at withdrawal. Roth accounts charge income taxes on contributions upfront, and you don’t owe anything at distribution. 

Nondeductible IRAs split your tax payments. So, you pay taxes on after-tax contributions before the contribution hits your IRA balance. But you’ll also owe taxes on any earnings from your investments. Taxes on growth are just deferred until distribution. 

Considerations before opening a nondeductible IRA

Nondeductible IRAs still defer taxes on earnings, which can reduce your overall tax liability as your account compounds. But the account can be a little more complicated than other IRAs, so we’ve outlined key points to consider: 

Commit to only after-tax contributions. 

Your eligibility for deductions might kick in again if your salary decreases or you switch jobs and lose 401(k) access. 

That doesn’t mean it’s time to enjoy tax-deductible contributions again. Mixing your contributions makes tracking taxes owed extremely difficult. It’s possible, but we wouldn’t recommend it. Failing to keep your contributions straight can trigger additional taxes. 

Consider other tax-saving options first.  

They’re still valuable with tax-deferred growth, but your overall tax strategy might benefit from other retirement plans. 

We always recommend maxing employer-match contributions first if you have access to a 401(k) or other plan. Pre-tax contributions will reduce your taxable income, and employer match is essentially free cash that compounds over time. 

Explore eligibility for other options like self-employment plans and Roth accounts with a financial advisor that can help you nail your account mix. 

Backdoor Roth conversions for bonus tax advantages

While traditional IRAs don’t have income limits for enrollment, your income can impact your eligibility for deductions. On the flip side, Roth IRAs have income limits that can disqualify you from making contributions in the first place. 

Luckily, there are no income limits on Roth conversions. So you can contribute after-tax contributions to a nondeductible traditional IRA, then convert the balance into a Roth IRA to enjoy years of tax-free growth. 

This route has a few perks:

• Reduced taxes at conversion: Nondeductible after-tax contributions are paid up with the government, so you don’t owe income taxes as you would with a pre-tax IRA conversion. You might owe on earnings up to the conversion date, though. 
• Tax-free growth: Nondeductible IRAs still charge taxes on distributions of earnings, but Roth IRA growth is tax-free so you don’t owe anything at withdrawal. 

Backdoor Roth conversions get tricky. 

If you miss a step or misreport your conversion, you might trigger expensive penalties or taxes. If you want the benefits of a Roth IRA but exceed the income limits for contributions, we highly recommend you work out a plan with a qualified advisor. 

The Playbook take: Nondeductible contributions still count toward retirement

Contributing to a nondeductible IRA isn’t a wasted tax benefit. They’re essentially after-tax contributions to a traditional IRA. You still defer taxes on investment growth until you make a withdrawal from the account, and you won’t owe a dime when you take out money you contributed. . 

That said, it may not be as beneficial to your retirement strategy as  traditional IRA tax deductions or tax-free growth in a Roth. But if you want to increase your contributions and already have an employer-provided plan, nondeductible IRAs can help.

Ready to focus on your financial goals and organize your investments? See how Playbook can help you save more of your wealth with a personalized financial plan and smart tax strategies.