Non-Deductible IRA

Aug 07, 2022 By Susan Kelly

Many of those people miss out on this simple chance to save more money for retirement, where it may grow tax-free. You and your spouse are eligible to make contributions to an IRA during any given tax year, provided that either of you has sufficient income from paid work or self-employment. The deadline for filing different individual and corporate tax returns, making tax payments, and contributing to an IRA in 2020 was extended to June 15, 2021, for taxpayers whose taxes were affected by the winter storms that hit Texas in 2021. (The extension granted by the IRS for those affected by the winter storms in 2021 was announced on February 22.)

For instance, during a certain tax year, you are permitted to make contributions to a Roth IRA, a traditional IRA, or a tax-deductible IRA, provided that the total amount of all contributions does not exceed the allowed maximum. A tax advisor may also assist you in determining how much of your RMD is taxable if it contains contributions that are not tax deductible. Contributions that are tax deductible and contributions that are not tax deductible may both be made to an IRA account; this is not possible with a Roth IRA.

Eligibility

Even if no payments were made to the plan during a particular tax year, your ability to fund various types of IRAs might still be subject to limitations based on your income, tax filing status, and eligibility to participate in an employer-sponsored retirement plan. These limitations may apply even if you have not contributed to the plan in the given tax year. There are no limitations on contributing the maximum amount to a deductible IRA if neither you nor your spouse participates in an employer-sponsored retirement plan at your place of employment.

Distributions

Once you begin getting distributions, it is necessary to have a form that details the amount of money you contributed after taxes. You are permitted to withdraw any amount from your IRA without incurring a penalty if you are between 59, 12, and 72, but you are not compelled to do so. If you have a Roth IRA, you are exempt from this requirement.

If you made contributions that were not tax-deductible, then any payout you get will include both taxable and nontaxable components. Your total contributions after taxes determine the percentage that is not taxable. In contrast, the taxable portion is determined by the amount of money your contributions produced over time. Consider the following scenario: during your working life, you have contributed $50,000 to a non-deductible individual retirement account (IRA), and as of the age of 72, that account has grown to $75,000. Approximately one-third, or $25,000, of the account's value increase would be subject to taxation as capital gains.

An IRS table uses your age to estimate the precise amount of your required minimum distribution (RMD). Your IRA custodian may give you a statement indicating how much you are required to withdraw, but it is better to have a tax adviser do this job for you. A tax advisor may also assist you in determining how much of your RMD is taxable if it contains contributions that are not tax deductible. As will become clear in a moment, maintaining accurate records of your financial contributions is another crucial step. The calculation used to determine the proportion of taxable to nontaxable income must be revised annually based on the value of all your IRA accounts as of December 31.

Documentation

The need to maintain records is a drawback of non-deductible IRAs. It is up to you to keep track of donations that are not tax deductible and submit a claim for them. To properly record your IRA contributions and withdrawals, the Internal Revenue Service (IRS) advises you to preserve copies of your 1040 and 8606 tax returns, in addition to the Form 5498 that you get annually from your IRA custodian. Contributions that are tax deductible and contributions that are not tax deductible may both be made to an IRA account; this is not possible with a Roth IRA. This is significant because the cost basis does not disappear at the IRA owner's death; rather, it is passed on to the surviving spouse or beneficiary.

The amount that may be contributed to a non-deductible IRA each year is capped, but those contributions can still accumulate throughout a retirement. If you started contributing $6,500 a year when you were 50 years old and continued doing so for the next 10 years, retired when you were 60 years old, and assuming a return rate of 6%, your contributions might increase to more than $150,000 by the time you were 70 years old. In addition, if you begin withdrawing money from the account, around 44 percent of the return on your investment will be tax-free.

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