"Nondeductible contributions" refers to contributions or donations that cannot be subtracted or deducted from your taxable income when calculating the amount of taxes you owe.
Full definition
Subject to various limitations, 401k plans and other retirement plans maintained by employers can offer the opportunity to
make nondeductible contributions instead of, or in addition to, deductible contributions.
Your investments will still grow tax deferred — which means
even nondeductible contributions to a Traditional IRA may be more profitable than keeping money in a non-tax-advantaged account.
If you convert only part of your traditional IRA, or if you have more than one traditional IRA and don't convert all of them, then the nontaxable part of your conversion distribution will be determined by a formula where the nontaxable percentage is the amount of your
total nondeductible contributions (less any nontaxable distributions you previously received) divided by the total balance of all of your traditional IRAs.
A: Yes, but when you determine how much of your conversion distribution is taxable, you're required to treat all your traditional IRAs as if they were one big IRA, so you don't get any advantage if you take the distribution out of the IRA that has the
most nondeductible contributions.
For example, if 60 % of your IRA balance comes
from nondeductible contributions and you convert $ 8,000 of that IRA, you'll report $ 3,200 of income from the conversion (40 % of $ 8,000).
You add up the total value of all traditional IRAs and also the total amount
of nondeductible contributions to those IRAs to determine what percentage of the conversion amount is taxable.
Your investments will still grow tax deferred — which means
even nondeductible contributions to a Traditional IRA may be more profitable than keeping money in a non-tax-advantaged account.
If you made
nondeductible contributions to your IRA, you must calculate your RMD based on the total balance, but your taxable income may be reduced proportionately for the after - tax contributions.
Why would you make
nondeductible contributions to a Traditional IRA?
It's possible to make
nondeductible contributions to a Traditional IRA, also called «after - tax contributions».
Distributions of
nondeductible contributions are not taxable.
In addition, you don't have to pay tax on the portion of withdrawals attributable to
nondeductible contributions that your mother made to the IRA (if any).
If I an correct, in traditional IRA, the basis, as in 8606, is the portion of the balance due to
nondeductible contribution.
That brings us to the second reason you might convert: Suppose that, in the past, you hadn't been eligible to fund either a tax - deductible IRA or a Roth IRA, so you ended up making
nondeductible contributions to your traditional IRA.
When you convert, you don't have to pay taxes on
those nondeductible contributions.
Even if you're not eligible to deduct your traditional IRA contribution, you can make
nondeductible contributions and still benefit from tax - deferred investment growth.
If you participate in a retirement plan maintained by your employer and your income is above certain levels, you may face a choice between saving in a Roth IRA or making
a nondeductible contribution to a traditional IRA.
You would make
a nondeductible contribution to a new TIRA, then convert it to a Roth.
Any money you contribute to a traditional IRA that you do not deduct on your tax return is a «
nondeductible contribution.»
If you didn't make
any nondeductible contributions, the taxable distribution would be the entire account balance of $ 50,000.
Because the aggregation rule makes the taxable distribution the same no matter which account you convert, you can't reduce the taxable distribution amount by converting an IRA with a larger proportion of
nondeductible contributions.
If you own several traditional IRAs, you must aggregate (add together) all their balances and
nondeductible contributions to determine the taxable distribution.
If you exceed the income limits, you can still make the maximum annual contribution, but a portion or all of it will be considered
a nondeductible contribution.
If you only have one traditional IRA, the amount of the distribution to be taxed equals the account balance on the conversion date minus
any nondeductible contributions.
Knock off 22 % from that sum for taxes, add back the $ 1,000
nondeductible contribution and the wife would be left with $ 8,243, compared with $ 6,231 for her husband.
Nondeductible contributions may necessitate some very complicated paperwork when you begin withdrawals from your account.
If
these nondeductible contributions represent your only IRA money, then you will just owe taxes on the earnings when you convert to a Roth IRA.
These accounts work much like Roth IRAs, allowing you to make
nondeductible contributions, build up investment earnings inside the account, and eventually withdraw the money, including earnings, without paying any tax if the money is used for college expenses.
Example: You have a traditional IRA with a balance of $ 10,000, which includes $ 6,000 of
nondeductible contributions.
If you roll $ 6,000 of this IRA to a Roth IRA, you're required to treat that rollover as coming 60 % from
nondeductible contributions and 40 % from other money — the part that's taxable.
You may have a conversion that's only partly taxable because you made
nondeductible contributions to a traditional IRA before the conversion.