Q. What are the tax implications for a traditional IRA when your AGI is above the threshold that allows any deductions on contributions?
If you file as a married couple and have an adjusted gross income of over $200k, and you want to contribute to a traditional IRA, will that amount be taxed twice? I understand that our income is above the threshold that allows any deductions on contributions. Also, for our traditional IRA, both principal and earnings are taxed at withdrawal.
A. As you mention, even though everyone with earned income (or a working spouse) can contribute to a Traditional IRA, some taxpayers may not be able to deduct the contribution. It appears you fall into that category! Sorry you can’t get the deduction but congratulations on having a great income!
All is not lost, though. You can track your non-deductible IRA contributions to your Traditional IRA on IRS Form 8606. When you later take withdrawals from your IRA, you can reduce the taxable income by a prorated share of your nondeductible contributions. This is best illustrated by example. Assume you contribute $5,000 to a Traditional IRA and are unable to deduct the contribution. Years later, the IRA has grown to $20,000 (with no additional contributions). The non-deductible contribution percentage of the IRA balance is 25% ($5,000/$20,000). Therefore, when you withdraw, for example, $8,000 from the IRA, you will only pay tax on $6,000 as the other $2,000 represents a return of your non-deducted contribution.
If you have no other IRA’s when you make the non-deductible IRA contribution, you could then do a Roth conversion with little to no tax due. It won’t allow you to deduct the contribution this year, but at least the funds will grow tax-free into the future (assuming you follow the Roth IRA rules, of course).
Thanks for your question!
John is a CPA and personal finance coach. Email your questions to firstname.lastname@example.org.
If you need confidential financial coaching for your particular situation, please contact John for a no-cost, no-obligation discussion of your needs.