You can’t deduct contributions to an IRA if your adjusted income exceeds certain levels in 2013 ($69,000 for singles and heads of household; $115,000 for married people filing jointly) and you are in a company retirement plan. Contributions can still be made up to the usual annual limits, but they are not deductible.
Here are three reasons why people would still make contributions:
<ul><li>Earnings compound at higher rate due to the fact that earnings within an IRA are tax free.</li>
<li>When funds are withdrawn, is the only time earnings are taxed. Subsequent distribution isn’t taxable since the initial contributions weren’t deductible. (Withdrawals are 100% taxable in IRAs that are funded by deductible contributions.)</li>
<li>When you want to fund a Roth but your income level won’t allow you to do so directly, under certain conditions, you can convert a nondeductible IRA to a Roth IRA. </li></ul>
Caveat: Even if you only withdraw from one IRA, when you have two or more, you can’t attribute withdrawals to just that one. The distribution from one IRA is treated as a pro-rata distribution from all of your IRAs. The taxable withdrawal percentage if you have two IRAs is determined by combining your IRA that is funded by nondeductible contributions along with your IRA that is funded by deductible contributions.
In situations where money could be used better elsewhere, it may be wiser to use other options. Also compare your potential earnings with an IRA to earnings with other investments. Review your options with a financial adviser before proceeding.
Contact us today at 706.353.1711 to discuss any questions you may have about taxes and your IRAs.