Before you make a nondeductible contribution to your IRA account, be sure you understand how they work.
If you have access to an employer sponsored retirement plan or if your income is above certain levels, you may not be eligible to make a tax deductible IRA contribution, but you could make a nondeductible contribution. The advantage to making a nondeductible IRA contribution is the tax deferred growth.
Tax deferred growth can be quite advantageous, as a difference in return of just a few percent can make a substantial difference in the amount you accumulate over a long time period.
But, before you do make a nondeductible contribution, be sure you understand the rules and consider your alternatives if you’re seeking tax advantaged growth.
I have personally worked with clients who have IRAs with nondeductible contributions, and the bookkeeping can become a nightmare, as you have to keep track of your deductible and nondeductible basis for your tax records.
When you start taking distributions, every year you’re going to have to recalculate how much of your distribution is taxable and how much is nontaxable, while keeping track of the original basis.
If you contribute to your IRAs over a long time frame, like 20 years or more, you’re going to have to keep the records of which contributions are deductible and which are nondeductible.
If you’re thinking about making nondeductible contributions, you’d better be adept at maintaining your files and you had better understand how much of the nondeductible contributions you can use.
Such contributions are not taxable when they are distributed, as you already paid the tax when you contributed. The amount of distribution, however, is based upon the total value of all your IRAs (including nondeductible) on 12/31 of each year during your RMD (required minimum distribution) period.
So, the non-taxable distribution from the nondeductible IRA must be recalculated each year. In addition, when you die, you will pass this calculation on to your IRA beneficiaries.
I know someone who has multiple IRAs and is now taking RMDs. Fortunately he is very meticulous about his record keeping and has kept files for over 20 years of all his contributions. Now, he has to keep track every year as the RMDs come out, and it has become a huge headache for him.
Think ahead carefully before making those nondeductible contributions to your retirement account and keep accurate records if you do.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
