An Individual Retirement Account (IRA) is a kind of retirement savings account with tax benefits. People do not need to be retirees to start an IRA, but they do need to be of retirement age to use it. An IRA is a great way to make long-term savings and investments.
There are different types of IRAs, one of which is the non-deductible IRA.
This article aims to shed some light on the topic of non-deductible IRAs and how to ensure that you are tax-efficient about it.
Non-Deductible IRA
A nondeductible IRA is a retirement savings account that you contribute to using after-tax dollars. However, it allows you to save for your retirement without paying taxes on your gains until you withdraw them.
The Roth and traditional IRAs contributions are limited based on your income. You can contribute if your income is low enough but lose the ability to do so if your income is too high. If you are eligible, IRA contributions come with various tax benefits, including tax deductions, tax credits, tax-deferred growth on earnings, or tax-free growth on earnings.
On the other hand, a non-deductible IRA does not limit your ability to make contributions. Regardless of your income, you can contribute to your IRA. However, you do not receive the same tax benefits as people with traditional and Roth IRAs.
Contribution Limits, Withdrawals, and Conditions
Non-deductible IRAs are helpful, especially those who wish to save and invest regardless of their income. However, not paying attention to the non-deductible IRA limits and conditions can result in tax inefficiencies.
Below are some of the things you need to know about non-deductible IRAs:
Contribution Limits
Non-deductible IRAs are subjected to contribution limits. Unlike traditional IRAs or 401(k) contributions that can be deducted in the same year they were made, you can only contribute to a non-deductible IRA with after-tax dollars.
Contribution Reporting
You need to let the IRS know that you have contributed to your IRA using after-tax dollars. To do this, you have to file your non-deductible IRA contributions using IRS Form 8606. Submitting this form each year ensures that you are not taxed on contributed money when you withdraw your funds during retirement.
Contribution Withdrawal Conditions
Contributions that you withdraw after retirement are tax-free. However, taxes may apply if you withdraw them before reaching retirement age. Failure to file Form 8606 may even result in being taxed twice.
Gains Withdrawal Conditions
Gains that you withdraw from your investment holdings will be taxed at the same rate as your other income. You do not get a tax deduction for contributions that you put into a non-deductible IRA, unlike a Roth IRA or Roth 401(k).
Non-Roth After-Tax IRA Contribution Rules
Before contributing to non-deductible, traditional, and Roth IRAs, you must understand the rules and procedures. Doing so can help you avoid tax inefficiencies and double tax traps during withdrawals.
When making contributions to non-Roth after-tax IRAs, some things that taxpayers need to know include:
- Earning an income is required for all individual contributors.
- Eligibility to participate in a retirement plan at work, filing status, and income determines the deductibility phase-out.
- Whichever is less than USD 6,000 ($7,000 for people over fifty years old) or earned income and applied to the aggregate IRA additions is the non-Roth IRA’s contribution limit.
Conclusion
IRAs are a great way to save for your retirement. You get to set aside money for your old age by investing in them. There are different types of IRAs, and each IRA can have its own benefits and limitations.
Non-deductible, traditional, and Roth IRAs come with limitations. You need to understand these limitations before contributing to any one of them. Failing to do so can increase your tax liability and lower your retirement savings.
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