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Many people make too much money to contribute to an Roth. You can get around this problem. High earners can still take advantage of the Roth IRA by contributing to a nondeductible IRA and then converting to a Roth. A nondeductible IRA is simply a traditional IRA for which there is no tax deduction, and it is available to almost everyone with wages or self-employment income.

A non-deductible Traditional IRA is a Traditional IRA that consists of non-deductible contributions. In both Roth IRA and non-deductible Traditional IRA, contributions are non-deductible, meaning that you fund them with after-tax money. The major difference comes from the way earnings are taxed. Earnings are taxed as ordinary income if you withdraw them from a non-deductible Traditional IRA. In contrast, earnings are tax free if you withdraw them from a Roth IRA.

You make non-deductible contributions to a Traditional IRA by setting up and sending money to an IRA custodian of your choice. You do not need to notify the IRA custodian that you are making non-deductible contributions. However, you do need to notify IRS that you have made non-deductible contributions to a Traditional IRA with Form 8606 Nondeductible IRAs when you file your tax return. It is your responsibility to keep track of the basis, the amount of non-deductible contributions, in your Traditional IRA. You can then convert this non-deductible Traditional IRA to a Roth IRA but make sure you get professionals help.

Remember that the IRS treats all of your (but not your spouse’s) non-Roth IRAs as one giant IRA. When you make non-deductible contributions to a Traditional IRA, you’ll have the basis, the amount of non-deductible contributions, reported on Form 8606. When you convert a part or all of your Traditional IRA to a Roth IRA, the conversion amount must contain the non-deductible portion proportionally. For example, if 5% of your non-Roth IRA are non-deductible contributions, then 5% of the conversion amount must be non-deductible contributions, and the rest must come from the deductible contributions, including earnings and rollover contributions. Notice that you cannot just convert the non-deductible part to a Roth IRA.

There are a couple of ways to work around this problem. The proportionate allocation rule does not apply to rollovers from an IRA to a QRP (Qualified Retirement Plan like a 401k) or 403b plan. Instead, a distribution that is rolled from and IRA to a QRP or 403b plan is deemed to come entirely out of the taxable portion of the IRA. This exception is necessary because the nontaxable portion of an IRA cannot be rolled into a QRP or 403b plan. You might therefore consider a rollover from your Traditional and non-traditional IRA back to a 401k or if you qualify as a self-employed business owner who can open a solo 401k, you might rollover your Traditional and non-traditional IRA to a solo 401k.

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One Response to “What Is A Non-Deductible Traditional IRA?”

  1. Name anon January 14, 2013 at 11:14 pm #

    this looks cut and pasted from bogleheads. Do you have a source for this… particularly the last paragraph? Can i rollover the taxable amounts to a QRP and the nontaxable amounts to a roth in the same year without triggering any tax consequences?