January 2008

Nondeductible IRA Contributions
By Traci A. Dunn     

            If you participate in an employer sponsored retirement plan, you may not qualify to make tax deductible contributions to an IRA. You can always make a contribution to a nondeductible IRA even though most people do not bother doing this since the contribution does not yield a tax deduction and the earnings are fully taxable as ordinary income when they are distributed.

            A Roth IRA is the preferred choice by people who want to maximize their retirement savings beyond what they are saving at work, if they qualify. The Roth IRA does not provide an upfront deduction but it does allow earnings to build up tax-free rather than tax deferred. If their income is too high to qualify for a Roth IRA, then some people might choose to invest in a taxable account-such as a tax efficient mutual fund that will yield lightly taxed capital income.

            A recent law change is making the use of a non-deductible IRA more appealing for taxpayers who cannot qualify for the Roth IRA. Beginning in 2010, a taxpayer can convert traditional IRA's to a Roth IRA regardless of their income level. Currently, only taxpayers with gross income of $100,000 or less can do this. Ordinary income tax is due at the time of the conversion on the income portion of the IRA, but future earnings accrue tax-free. Additionally, for conversions in 2010, the new law allows the resulting tax to be paid over two years, 2011 and 2012. If you have multiple traditional IRA's, you may have to allocate basis from the non-deductible IRA's to the deductible IRA's which may make this unattractive.

            If you are under age 70 1/2 and want to maximize the funds that can go into a Roth IRA, you should be funding nondeductible IRA's now. You can fund up to the lesser of your earned income or $4,000 if you are under 50 or $5,000 if you are 50 or older by the end of the year for which you are making the contribution. There is still time to fund an IRA for 2007 as long as you make the contribution by April 15, 2008.

            As always, we are here to help, so please call us if you would like to know more about this opportunity for maximizing the tax efficiency of your retirement savings.