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SLYKTAX
Level 3

What are Non-deductible Contributions

There are so many taxed terms that confused me.

As I understand that ROTH IRA is where you put your after-tax contribution with future distribution taxed free and Tradition IRA or 457 IRA is where you put your pre-tax contributions and are subjected to taxes on the distributions.

Then, there is the words ”non-deductible contribution”, what does that “non-deductible” applies with regard to your income?  In a W2 form, we have Wages and Medicare wages and also C, G and DD on lines 12a, 12b and 12c respectively. Isn’t what is non or deductible already taken care?  So,  is pre-tax contribution deductible?

Also, Investopedia Website says:

Basically, you must file Form 8606 for every year you contribute after-tax amounts (non-deductible contributions) to you Traditional IRA.

Is there an IRA that you contributed with your after-tax dollars? If so, what is the advantages consider that you can simply open an investment account with your after-tax dollars and why have IRA come into play? Please advise.

2 Best answer

Accepted Solutions
macuser_22
Level 15

What are Non-deductible Contributions


@SLYKTAX wrote:

Still not too clear Sir.  I assumed you said that IRA contribution  which is pre-tax  is the deductible and Roth is not.  But why would  someone want to put his non-deductible (after-tax) to his IRA to be constrained by RMD later instead of just putting into a stock investment account without being constrained by RMD? 

 


Most people contribute to a Roth IRA for that reason.    But their income might  be too high to allow any Roth contribution so they make a non-deductible Tradition IRA contribution instead and then convert that to a Roth.  That only works it that was the only money in the Traditional IRA.

 

Before Roth IRA's many people made non-deductible contributions so the tax would be lower on distributions  after retirement and the earnings could grow tax free over the years so the earnings could produce more earnings.

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**

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macuser_22
Level 15

What are Non-deductible Contributions


@SLYKTAX wrote:

Thanks.  Now I see why anyone would want to put a non-deductible into an IRA with the intent to rollover to Roth for one reason.   So there are two different IRA accounts one for non-deductible and another deductible? A If that is the case, are taxes on distributions the same? Is there a limit to the non-deductible contribution?


No.   Can be the same account with a mixture of deductible and non -deductible contributions.  

 

The contribution limit is the same for ANY contribution - deductible or non-deductible.

 

Tax on any distribution is prorated by applying the non-deductible basis between the distribution and years end value  of all Traditional, SEP or SIMPLE accounts.

 

That is done on a 8606 form.

 

It can be calculated this way.

non-taxable amount = (basis * distribution) / (year end value + distribution)

 

 

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**

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6 Replies
BillM223
Employee Tax Expert

What are Non-deductible Contributions

Before Roth IRAs were invented, there was the situation of taxpayers being able to contribute to a traditional IRA, but exceeding the annual limit for deductible contributions. This was based on the MAGI of the taxpayer (and spouse) and whether the taxpayer or the spouse was covered by a retirement plan at work.

 

Had Roth IRAs been invented at the same time as traditional IRAs, then it wouldn't have made a lot of sense to also allow nondeductible contributions to a traditional IRA, which is the source of your confusion.

 

It is certainly much easier today to make all your deductible IRA contributions to a traditional IRA and the nondeductible ones to the Roth IRA - this would remove the need to using form 8606 to track the "basis" (amount of nondeductible contributions in the traditional IRA).

 

However, given that the traditional IRA predates the Roth IRA by more than 20 years, rules had to be invented to accommodate traditional IRAs that already had nondeductible contributions - hence form 8606.

 

NOTE: IRA contributions are not reported on your W-2, because it is a personal account not done through your employer. Instead the deduction to a traditional IRA is shown on line 19 of Schedule 1 (1040).

 

Make sense?

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SLYKTAX
Level 3

What are Non-deductible Contributions

Still not too clear Sir.  I assumed you said that IRA contribution  which is pre-tax  is the deductible and Roth is not.  But why would  someone want to put his non-deductible (after-tax) to his IRA to be constrained by RMD later instead of just putting into a stock investment account without being constrained by RMD? 

I have 457 Deferred Comp which is for government employees and I believed is also considered IRA. You said  IRA contributions are not reported on your W-2.  But in my W2, my 457 contribution is shown in Line 12b with a "G" abbreviation.   Again it is a personal account but it is also set up by my employer but manage by a Financial Company like VOYA.  But you said it is not.  I am getting more confused.

macuser_22
Level 15

What are Non-deductible Contributions


@SLYKTAX wrote:

Still not too clear Sir.  I assumed you said that IRA contribution  which is pre-tax  is the deductible and Roth is not.  But why would  someone want to put his non-deductible (after-tax) to his IRA to be constrained by RMD later instead of just putting into a stock investment account without being constrained by RMD? 

 


Most people contribute to a Roth IRA for that reason.    But their income might  be too high to allow any Roth contribution so they make a non-deductible Tradition IRA contribution instead and then convert that to a Roth.  That only works it that was the only money in the Traditional IRA.

 

Before Roth IRA's many people made non-deductible contributions so the tax would be lower on distributions  after retirement and the earnings could grow tax free over the years so the earnings could produce more earnings.

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**

View solution in original post

SLYKTAX
Level 3

What are Non-deductible Contributions

Thanks.  Now I see why anyone would want to put a non-deductible into an IRA with the intent to rollover to Roth for one reason.   So there are two different IRA accounts one for non-deductible and another deductible? A If that is the case, are taxes on distributions the same? Is there a limit to the non-deductible contribution?

macuser_22
Level 15

What are Non-deductible Contributions


@SLYKTAX wrote:

Thanks.  Now I see why anyone would want to put a non-deductible into an IRA with the intent to rollover to Roth for one reason.   So there are two different IRA accounts one for non-deductible and another deductible? A If that is the case, are taxes on distributions the same? Is there a limit to the non-deductible contribution?


No.   Can be the same account with a mixture of deductible and non -deductible contributions.  

 

The contribution limit is the same for ANY contribution - deductible or non-deductible.

 

Tax on any distribution is prorated by applying the non-deductible basis between the distribution and years end value  of all Traditional, SEP or SIMPLE accounts.

 

That is done on a 8606 form.

 

It can be calculated this way.

non-taxable amount = (basis * distribution) / (year end value + distribution)

 

 

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**

View solution in original post

SLYKTAX
Level 3

What are Non-deductible Contributions

Appreciate for the explanation.  Thanks.

That makes sense based on the basis of the contributions as you just shown.

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