Deductible Pretax Traditional IRA Contributions vs Nondeductible IRA Contribution

First, the term “Traditional IRA” refers to an IRA that is not a Roth IRA. A contribution to a Traditional IRA can come in two flavors. The first flavor is as a deductible pretax traditional IRA contribution and the second as a nondeductible (after-tax) IRA contribution.

Nondeductible IRA:

A nondeductible IRA is a traditional IRA whose contributions are not deductible for federal income tax purposes (i.e., you cannot take a deduction on your personal Form 1040 tax return).

Nondeductible IRA contributions are reported on Form 8606 which is attached to the IRA owner’s Form 1040 tax return.

Traditional IRA:

Unlike a nondeductible IRA, the annual contribution to a traditional IRA  is tax deductible but only if:

(1) The IRA owner is NOT an active participant in a retirement plan such as a traditional 401k (i.e., a full-time employer 401k plan) or a self-employed 401k plan such as a solo 401k plan and;

(2) the IRA owner’s adjusted gross income is not too high.

Example AGI too High:

Bob is 32 years old and single. In 2020 his modified AGI is $80,000. Bob contributes $6,000 to his IRA for 2020. Because his AGI is above $75,000, he can’t deduct his $6,000 IRA contribution. See the following IRS page for more information. https://www.irs.gov/publications/p590a

Instead, the contribution must be treated as a nondeductible IRA contribution by reporting it on Form 8606.

EXAMPLE Also Participating in a Solo 401k Plan or A Traditional 401k at Work

Bob is 32 years old and single. In 2020 he was participating in his solo 401k plan. His modified AGI is $95,000. Bob contributes $6,000 to his IRA for 2020. Because he was participating in a solo 401k plan and his AGI is above $75,000, he can’t deduct his $6,000 IRA contribution. See the chart on the following page: https://www.mysolo401k.net/can-i-contribute-to-a-solo-401k-roth-ira-and-traditional-ira-for-2020/

Instead, the contribution must be treated as a nondeductible IRA contribution by reporting it on Form 8606.

Tidbits

The IRA owner may choose to make nondeductible IRA contributions instead of deductible Traditional IRA contributions even if he or she qualifies for the tax deduction.

Earnings on nondeductible IRA contributions are not subject to income taxes until distributed from the IRA.

The annual IRA contribution, whether deductible or not, may be made ahead of time during the year even if you don’t know how much if any will be deductible. You can then determine by the time your file your Form 1040 tax return if any amount is tax deductible.

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About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>

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