Contributions made to traditional IRA with after tax dollars

[krizan628]

My wife switched jobs earlier this year and she is not eligible for their 401k for 1 year.  Since that was the case we starting putting money into a traditional IRA every month with after tax dollars.  So far we have contributed $2,044 year to date. 

I have a 401k at my job and I will be contributing the $20,500 max this year.  The problem (if you can call it that) is that our income is going to be higher this year than we were expecting and our modified adjusted gross income will likely be higher than $214,000 even after maxing out the 401k & HSA contributions.  Are we going to be penalized for the IRA contributions or can we just leave them alone since they were made with after tax dollars?

[Critter-3]

You can leave them in the IRA even if the contributions will not be deductible on the return.  The portion that is non deductible will be carried on the form 8606 until the IRA has either been fully distributed or converted to a ROTH.

[Mike9241]

magi. 

Married filing jointly (spouse covered by retirement plan at work)	2022: Less than $204,000. 2023: Less than $218,000.	Full deduction.
	2022: More than $204,000, but less than $214,000. 2023: More than $218,000, but less than $228,000.	Partial deduction.
	2022: More than $214,000. 2023: More than $228,00.	No deduction.

[Opus 17]

You are correct that you aren't allowed to deduct the contributions.  However, you can leave the contributions in the account as non-deductible contributions, and they will be non-taxable when you withdraw them.  For example, when you retire, if the account balance is $20,000 and contains @$20,000 of non-deductible contributions (10%), then 10% of the withdrawals will be non-taxable since it represents money that was already taxed.   Non-deductible contributions are tracked on form 8606 and you must keep all your form 8606s as long as you have the IRA, they are an exception to the rule that you can discard most tax forms after 3 or 7 years.

Also, your wife can rollover the money into a Roth IRA after making the non-deductible contribution to a regular IRA, even though she isn't allowed to directly make a Roth IRA contribution due to your income.  This is called a "back door" Roth IRA.  For this to work, your wife would need to rollover all of her balances in traditional (pre-tax) IRA accounts (prior job retirement accounts don't count because they aren't IRAs even though they serve the same purpose).  Any IRA balance that is from pre-tax contributions is taxable as a Roth conversion, but if the only IRA amounts are non-deductible, then there is no additional tax and getting the money into a Roth IRA may have advantages over leaving it in a traditional IRA.  

[dmertz]

Presumably the contribution was made to your wife's traditional IRA, not yours.

If your wife's balance in traditional IRAs is attributable entirely to these contributions, it would likely make sense to do a Roth conversion (not a recharacterization) of the balance.

Even though the traditional IRA contribution is not an excess contribution and is not subject to penalty, your wife still has the option to remove the contribution (although that generally would not make sense if converting to Roth makes sense).

[Opus 17]

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@dmertz wrote:

Even though the traditional IRA contribution is not an excess contribution and is not subject to penalty, your wife still has the option to remove the contribution (although that generally would not make sense if converting to Roth makes sense).

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I didn't mention that because the taxpayer is clearly thinking of retirement accounts.

The spouse could remove all contributions before the end of the year, and just invest them someplace else.  The investment might earn interest and dividends, which are taxable yearly, and capital gains when sold, which are taxable in the year sold.  

But a Roth IRA would be entirely tax-free on withdrawal, you just can't withdraw right away.

I don't think a recharacterization to Roth contributions would be allowed here since the income will be too high for a direct Roth contribution.   But the backdoor Roth is allowed. 

[krizan628]

The contributions were made to my wife's existing IRA with a balance over $50,000.  The entire IRA balance besides the $2,044 of non deductible contributions were made using pretax dollars so rolling the non deductible contributions into a Roth seems like it would be difficult.   Am I able to withdraw the $2,044 of contributions made with after tax dollars without a penalty?

[dmertz]

A return of contribution in the amount of $2,044 could be requested.  The amount distributed would be adjusted for investment gain of loss over the entire account for the period beginning on the date of the first contribution through the date of the distribution.  Attributable gains would be subject to tax and, if your wife is under age 59½ at the time of the distribution to a 10% early-distribution penalty, but the $2,044 itself would not be subject to tax or penalty.

[fanfare]

you can ask the custodian to withdraw and return the contribution. it will be plus or minus any earnings while the money was in there.

Most persons don't want to track basis in an IRA for the rest of their life.

I recommend Roth IRAs now over Traditional IRAs .

And I'm trying to educate my niece on this topic and anyone else who will listen.

@krizan628 

[krizan628]

Thank you for the help.  I think I will just leave the non deductible contributions in the IRA and let it grow tax free.  Hopefully I can remember that I have form 8606 when I retire 30 years from now.  

[fanfare]

Any growth in a Traditional IRA due to your non-deductible contribution is not tax free !

@krizan628 

[Opus 17]

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@krizan628 wrote:

The contributions were made to my wife's existing IRA with a balance over $50,000.  The entire IRA balance besides the $2,044 of non deductible contributions were made using pretax dollars so rolling the non deductible contributions into a Roth seems like it would be difficult.   Am I able to withdraw the $2,044 of contributions made with after tax dollars without a penalty?

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There might still be an argument to be made for doing the Roth conversion, even though most of the conversion will be taxable.  A financial analyst might have to help you run the numbers for current and future implications.  But, you can withdraw the contributions before the end of the year.  

[Critter-3]

SAVE A COPY OF THE 8606 FORM  WITH YOUR IRA PAPERWORK (not just with your return) .... you will need the prior year copy for each year you make a non deductible contribution and/or convert to a ROTH.  You only need to keep the most current copy  and rest assured if you don't keep the records the IRS will not so if they ever question it you have the proof.