Should I Contribute To A Non-Deductible IRA? Part 1: Future Roth IRA Rollover

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As we’ve seen, after you reach a certain income, both Roth IRAs and tax-deductible contributions to Traditional IRAs are no longer available. After you max out your 401(k) or 403(b) plan at $15,500 per year, you start running out of tax-advantaged accounts quickly. One option is to contribute to a Traditional IRA anyways, even though the contribution will not be tax-deductible. Everything else is the same: your money will still grow tax-free, and withdrawals will be taxed at your ordinary income tax rate. You can sock away $4,000 for 2007 and $5,000 for 2008. So should you do it? I have less than three weeks before I need to decide!

There appear to be two primary ways to answer this question:

  1. Future Roth Rollover. In 2010, there will no longer be any income restrictions for Traditional-to-Roth IRA rollovers. Could this mean Roth IRAs for everyone?
  2. Compare Returns vs. Taxable Account. If you either can’t or don’t wish to convert to a Roth, will your performance at least be better than a regular taxable account?

Future Roth IRA Rollover

According to current laws, in 2010 the income restriction for Traditional-to-Roth IRA rollover will disappear. Since you’ve already paid taxes on your non-deductible IRA contributions, you will only have to pay income tax on the earning portion when you rollover. This can be seen as effectively allowing you a way to contribute to a Roth IRA down the road. Now, instead of having to pay ordinary taxes upon withdrawal, I don’t have to pay any taxes! I even avoid required minimum distributions.

Catch #1: The Law May Change
I have seen no indication that this Roth “back door” was intentional. Some people see this as simply an oversight that a busy (or lazy) Congress simply hasn’t gotten around to changing… yet. For example, the current low 15% long-term capital gains rate is also scheduled to go up in 2011. Others think that the lure of tax revenue now gained through Roth conversions might be appealing and they’ll let it stay. Now I’ve waited until the last minute to make my decision and it’s almost mid-2008, and nothing has changed, so maybe it’ll happen…

Catch #2: Mixing Deductible and Non-Deductible Contributions
Let’s say you have $10,000 in a Traditional IRA, $4,000 of which was a non-deductible contribution, and $6,000 of which was deductible contributions and earnings within the IRA. If you wanted to convert $4,000 of it over to a Roth IRA, you can’t simply pick out the non-deductible contribution. The $4,000 would be pro-rated to be 40% non-taxable and 60% taxable, in the same proportions as your total IRA.
The only way to convert all of your non-deductible contributions would be to convert everything together, which might not be ideal.

One way around this is to first roll over your deductible IRA money into another qualified retirement plan like your 401(k) if they allow such transfers (and you like your investment options). Then make your non-deductible IRA contribution. That way, the deductible and non-deductible parts can be separated. I don’t have any deductible IRA funds, but I think I could rollover into my Solo 401(k) if desired.

Catch #3: More Paperwork
If you make non-deductible contributions, conversions, or withdrawals you must document them each year using with IRS Form 8606. It’s probably a good idea to simply file the form every year so that you don’t end up forgetting and having to pay extra taxes later.

In general, I think the Roth conversion option is great if it’s available, but I am still not convinced it will still be around in 2010. So I’d better make sure that’s a non-deductible IRA is still a decent deal even without that option. To be continued in Part 2…

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  1. I thought you were self-employed. The solo K or SEP-IRA limits are much higher.

  2. None deductible IRA is not as good as just sticking it in a stock index fund in a taxable since in the end you will be taxed at your ordinary income tax rate in none deductible IRA vs. long term capital gains tax in an taxable account. I’m glad my none deductible IRA decision won’t occur until 2010 right when the law will (or will not) be in effect. I think it will be there since congress is trying to get that extra tax on all the deductible IRAs.

  3. I wish you had made this post in January! I had to figure out the hard way about the 8606 form and now have to fill it out and submit it separately from my regular tax forms.

    Great post though! I’m currently working on a system that uses both the Roth and a traditional non-deductable IRA. My husband and I are quickly approaching the income limit of the Roth, so we are contributing now while we can and will then transfer over to a traditional IRA once the Roth is no longer an option for us.

  4. I ran into this situation in 2007. In fact, I even made non-deductible contributions to a traditional IRA for 2007 for both me and my spouse. I maxed out my 401k for the year, so the non-deductible IRA was my only option for additional savings. However, after consideration, I’ve decided to reverse those contributions and just place the money in an index fund. First, for my wife, she has a rollover IRA which is pre-tax, so if I rolled the new IRA to a Roth, I’d have to pay taxes on any money from the rollover IRA to the Roth. The IRS rules require you to consider ALL IRAs, you can’t just pick and choose which ones count for the rollover. Second, I assume more favorable treatment of dividends and capital gains going forward over ordinary tax rate. For example, assuming a 40-year horizon, 8% return and a favored tax rate of 20% for ongoing dividends/cap gains compared to an ordinary tax rate of 33% at retirement, the taxable account and non-deductible IRA are about equal. Given the flexibility of a taxable account, I’m opting for that route.

  5. I’ve always been under the impression the conversion loophole was intentional to lure a large number of conversions today rather than waiting several decades for Uncle Sam to have his take.

  6. The reason for making the non-deductible IRA contributions is to take advantage of the 2010 Roth rollover, so the point about the LT cap gains is moot.

    Re. Catch #2 – I don’t think you can roll Traditional IRA holdings into Employer Retirement Plans…or at least not into a 401(k) or a 403(b) plan.

    Best thing to do is just open up another Traditional IRA and make your non-deductible contributions into this new IRA, to keep your non-deductible contributions vs. deductible contributions separate. This alleviates a lot of the tracking issues you would have if you combined the IRAs into one account.

  7. I agree with Tom. A couple more issues:

    1) How much extra $$ would this manuever have to earn you for it to be worth the risk of forgetting to file that lousy extra form one year and then owing some unforeseeable amount of penalties/taxes for it? Remember that retirement is decades away for you (is that right?), and to me the burden of Yet Another Darned Thing better have a HUGE payoff for it to be worth complicating my finances even that little bit more.

    2) Taxation risk diversification: I know a lot of people are taking the “I paid taxes upfront already” promise that the Roth has at face value. We are now entering untested economic waters with two foreseeable events: the credit crunch along with the globalization of finances, which means *there may be no safe place to hide* from the effects of the fallout; and the Boomers retiring en masse. I am concerned that the Roth promise may not be honored by a Congress 30-40 years from now, and they’ll tax it again because they’ll have to in order to remain solvent, especially if a lot of people perceived to be “rich” put money into it (the truly rich of course can afford people to squirrel their money somewhere truly untouchable). So I have some money in the Roth IRA, and some in a traditional IRA/401k on the hope that they will get treated differently in the future, thus diversifying my risk of tax treatments.

    My point here is that so far I’ve only seen punishment for people who save by Congress and the Fed in how they are choosing to deal with the current credit crisis (in that they are willing to flirt with massive inflation, and taxpayer money propping up of banks who took on massive subprime exposure). I don’t expect this philosophy to change anytime soon, so caveat Roth in hoping it to be a completely untouchable shelter.

  8. You say you are not sure it will be around in 2010, there is no doubt it will. George Bush signed a bill for this to happen but its a one year thing only. Maybe there will be another bill to set it up for following years but as of now, its a one time occurrence.

    I agree, I dont see how you can roll non employer sponsored plans into a 401k account. Maybe a Rollover IRA… you should have one of those anyway.

  9. I started contributing the ND-IRA for exactly this reason. I think even if the loophole in 2010 fails to materialize, it’s a nearly free option. Also given that at some point I’m probably going to get out the rat race and see my income drop, I should be eligible for a conversion then as well.

    And even if all that doesn’t happen, I see the IRAs as area where I can potentially quickly flip stocks. I tend to buy very similar holding in my taxable and non-taxable account, and I often will sell shares in the IRA account and hold shares in my taxable account (for LT Cap Gains). Having more money in tax sheltered accounts gives me more flexibility.

  10. Good Post. I don’t think a lot of people realize the whole part about #2.

    Catch #3 also alludes to the fact that if you contribute to non-deductible IRAs, you build basis. But it is only going to help you if you keep good records. (I mean if you are retiring in 40 years you need to keep these records for 40 years plus!!). Otherwise you risk being double taxed. No one else is going to track your basis or care, but YOU.

    As far as catch #1 – this if the caveat for ANY tax planning. The tax law is always changing. However, my understanding was that this “loophole” was quite intentional – to raise tax revenues in 2010. I hesitate to even use the word “loophole” because a true loophole is generally obscure and/or unintentional. This is clearly neither. Congress put it in the tax code plain as day, and everyone knows about it.

  11. Also keep in mind that a non-deductible IRA is a great place if you don’t have other tax-deferred space for them. It’s also fine for REITs.

  12. I don’t think Phoenix’s third paragraph is correct, I would advise everyone to look into it, before doing what he says.

  13. Artie McDonald says

    >I have seen no indication that this Roth “back door” was intentional.

    Actually, this provision of the tax code was most certainly intentional as it and the 2011 “sunset” provisions was part of the 2001 tax cut package passed by congress that year. To make it affordable, most of the provisions in this tax cut were phased in over the 10 years (some accelerated by the 2003 tax cuts) and the last two provisions that have yet to “phase in” are the elimination of the ROTH IRA income limits, and the repeal of the estate tax.

    The Sunset came about because the Senate failed to get the 60 votes needed to bypass the “Byrd Rule” needed to make the tax law changes permanent from the get go. (Of course no law congress passes is ever permanent.)

    This is why this seems to be a one year “loophole”. On 1-1-2011, the tax code simply rolls all the way back to the 2001 levels (with the exception of the items congress has since voted on to make permanent.).

    This means the limits on IRA, 401k, the catch-up contributions, the estate tax exemptions, the 10% income tax bracket, the marriage penalty, dividend taxes, the child tax credit, etc all return to what they were based on the laws in effect before 2001. IE, this means the IRA limit is $2,000 again and all income limits are back on the books. Pretax contribution limits will dramatically fall. All the catch-up contributions will be disallowed. Dividends are taxed as ordinary income again. Married persons with similar incomes will pay more in tax that two single persons making the same money. The child tax credit drops from $1000 to $500. Failing to die with a large estate between 1-1-2010 and 12-31-2010 will be costly.

    Also, as Johnathan pointed out, the 5% reduction in the long term capital gains taxes goes away. It’s currently 15% (0% for low income persons starting in 2008, 10% before that) and will revert to 20% and 15% in 2011.

    In fact, the sunset of the 2001 law will see the return of the “super long term” holding period which was originally scheduled to appear in 2001, but was superseded by the 2001 tax changes that provided lower rates. However, the old rule is still on the books. Unless congress makes the 2001 law provisions permanent, in 2011, we revert back to the old rule of having three holding periods for capital gains…. Short term (1 year but 5 years).

    >Some people see this as simply an oversight that a busy (or lazy) Congress simply hasn’t gotten around to changing…

    So in actuality this was a gamble by congress by accepting a 10 year slow roll in of these tax provisions the bet is that once they have gone into effect they will be popular enough that eventually future congresses will have no choice but to extend the provisions.

    So far, of the major provisions of the 2001 tax reform that have become permanent on future votes by congress and are no longer set to auto-expire.

    The tax free treatment of qualified 529 distributions is now permanent.
    The ROTH 401k will not expire and is now permanent.

    Of course, all of those can be changes by future acts of congress.

  14. Artie McDonald says

    >Per Alex: I don’t think Phoenix’s third paragraph is correct, I would advise everyone to look into it, before doing what he says.

    Actually, Phoenix’s advice is correct and very wise thing to do. For traditional IRA, you establish and track your basis in each account separately. If you maintain two separate accounts for pre tax and after tax contributions it makes the calculations of the basis much easier when you take a taxable portion of distributions. You also give your self flexibility when you take distributions whether to tap the deductible account (which has $0 basis and owe tax on the full distribution), or tap the non deductible account (which will have a basis, and you only pay taxes on the prorated share of the distribution that consists of earnings).

    Commingling pre-tax and after-tax money in a single IRA is just asking for paperwork headaches in the future. Plus, if you choose to convert a commingled account to a ROTH, the amount you convert will be proportionally allocated to the pre-tax, post-tax, and earnings portion and taxed accordingly. Whereas if the amounts were kept separately, you can elect to only convert the post-tax account and only take the tax hit on the earnings in that account, and leave the pre tax account behind.

    BTW, the rules are completely different for a ROTH… When distributions are taken from a roth… You establish basis in your ROTH holdings in aggregate. Regardless of how many ROTHs you hold, you consider all your ROTHs as one when calculating taxes on distributions, and you always take out contributions first, before conversion and earning amounts. Even if all your ROTH contributions went to account A, and all your rollovers, went into account B… If you take your first ROTH distribution from B, that distributions is considered to be a withdrawal of contributions (up to the amount you your total to date contributions) and the basis will be the amount of the distribution. This treatment of distributions is yet another reason why ROTHs are so much more favorable than traditional IRAs.

  15. Alex is correct–as far as the IRS is concerned, it treats all of your IRAs together as one IRA. I also meant to say in my previous comment that a non-deductible IRA may be a great place for bonds, but somehow the bonds part was lost.

  16. Black Hammer says

    My wife and I are above the Roth qualified phase-out. Luckily my employer allows me to split 401k and Roth401k for my retirement contributions, which overall I will max out on this year.

    I just recently bought the Go Roth! book from and the Traditional to Roth conversion seems more complicated than you make it out to be. I still have to study this more I’m sure.

  17. – Yes, Solo 401k has higher limits, as long as you have the income to cover it. I am only partially self-employed on the side.

    – In 2010, isn’t there still a scheduled income limit for Roth IRA contributions? If so, making it okay to do a Traditional contribution and then converting it to a Roth would make it seem unintentional to me. Otherwise, why not remove the income restrictions for all direct Roth IRA contributions?

  18. This is definitely one confusing topic.

    I, too, had to do the 8606 thing last year. What’s more………..despite my comforting by Turbo Tax folks………I adamantly claim that Turbo Tax did ***NOT*** walk me thru the proper steps so that the actual FORMS showed my recharactarization.

    Who the !@%$! knew what a *recharactarization* meant before all this crap anyway??

    So now I have……

    #1.) My old traditional IRA which I can no longer deduct, so no-longer contribute to

    #2.) My new Roth IRA, part of which I recharactarized my contributions into from my TIRA last year.

    #3.) My SIMPLE IRA which is taxed………well………I’m not even sure how.

    So I have, like 3 different tax scenarios and I’m scared to death of how I’m gonna keep track of ’em all in another 30 years. All I know right now is…….CONTRIBUTE NOW………WORRY ABOUT HOW IT’LL BE TAXED, LATER!


  19. Red – Talk to a financial advisor now for 1 hr, get your situation straightened out now so you don’t complicate the situation later.

    Jonathan – regarding your Home Depot experience — i recommend you find another hardware store soon (if there are some in your area). Even if that means driving further to get things. Home Depot’s items are NOT off the shelves b/c they’re selling well, they’re off the shelves b/c the bean counters are trying to control which items (read: HIGHER MARGIN PRODUCTS) are sold at various times of the year. I’d write more about this but i gotta leave work now.

  20. Artie McDonald says


    Yeah, totally disregard my second comment from earlier today, as I had it completely wrong… I’ve really got to redo my IRA plan with this reality, as the 2010 loophole all of a sudden looks less worthy for someone who may have a large rollover IRA that has no-basis. Self note: Pub 590 is your friend…

    Alex and Hmm, are absolutely correct… The basis in all IRA, SEP, or SIMPLE IRA are aggregated when a distribution (or a ROTH conversion) is made and if there is a basis, the distribution will always have a taxable and non-taxable amount.

    There is one exception to this. IE, if you make a rollover from a traditional IRA into a non-IRA (ie an annuity, a 401k, 457, 403b, etc) then you can roll over only pre-tax amounts and leave behind the after-tax funds. There is a small blurb on this on page 24 of pub 590.

  21. – I should have been more clear in my post. Having “separate” IRA accounts doesn’t mean anything, in the eyes of the IRS they are all taken as a whole. Any conversion amounts are pro-rated into pre-tax and post-tax accordingly.

    – Many 401(k) and other qualified plans as well as Solo 401(k) plans accept rollovers FROM other IRAs. In fact, some people do this explicitly in order to be allowed to take 401(k) loans from their IRA balances. Maybe not a good idea, but it is definitely done.

    – I’m still not convinced this was intentional, but I will be perfectly happy to take advantage of it if the one-year window remains open.

  22. Phoenix,

    Thanks, but my comments were a bit tongue-in-cheek.

    The plan is to either leave the traditional IRA stuff alone, or convert it in 2010 (and pay whatever tax-debt would be owed as it was previously deducted) based on whichever is most tax advantagous.

    (Though we all know the gov’t could pull the plug on Roth advantages in the future and there ain’t a whole lotta squat we can do about it.)

    My SIMPLE IRA will stay as-is, because I’m offered matching via my employer and has much higher limits that are exclusive of either my Traditional *or* Roth IRA annual limits. (kinda’ nice to have as supplemental)

    Now, if the gov’t throws poop in the fan blades come 2010, all bets are off, but who really knows ’til we actually get there.

  23. I want to point out the removal of income limit for conversion to Roth is not a one-year deal for only 2010. As the law currently stands, it’s for 2010 and every year thereafter. Lower income and qualified dividends and capital gains tax rates expire after 2010 but this ability to convert to Roth IRA without income limit does not expire. See:


  24. Does anyone know if the 2010 rollover rules for traditional IRA to Roth IRAs are the same for a rollover from a SEP-IRA to a Roth IRA?

    Can SEP-IRAs be rolled over into Roth IRAs in 2010 without income limit restrictions? Can both non-deductable and deductable contributions to a SEP be rolled over at that time?

  25. My wife has taken early retirement and received $8000 in 2008 from the state retirement fund. She made a non-deductible traditional IRA contribution of $6000. As a result only $2000 of the retirement distribution is taxable. A unique situation but definitely beneficial to us. We will see about the Roth IRA in 2010.

  26. I started loading up a ND IRA 3 years ago in preparation for 2010. I am really liking this now since I will have no gains to report given this recession.

  27. what happens to my loss if if I convert a non-deductible IRA to a Roth IRA, and my non-deductible IRA is worth less than the amount I contributed? Do I get a tax deduction for the loss?

  28. Jonathan,
    Since I am ineligible for Roth IRA and even Tradition IRA due to income limits; can I contribute $5000 this year to a non deductible IRA? And then roll it over to a Roth IRA, since there are no income limits?

    Technically would this not work as the same as contributing to Roth IRA with no income limits? So no tax in the future and since the non-deductible contribution is with after tax money; there would be a huge benefit over continuing to keep the money in non deductible IRA.

    Am I missing something or is this legally possible?

  29. I think the following strategy is a perfectly legitimate way to defer taxes for those of us with a 457 or 403(b) plan, but unfortunately, not for those with a 401(k) plan. It appears that money from a traditional IRA can be rolled over into a 457 or 403(b) plan, if your employer set up the plan to accept these rollovers, and such a rollover can eliminate the tax bite of converting non-deductible contribution from a traditional IRA to a Roth IRA. Here goes:

    Suppose you have made $20K of non-deductible contributions to a traditional IRA and the total of deductible contributions and earnings is $30K. That is, suppose your cost basis is 40% of the $50K total. In 2010, regardless of your income, you can roll over $20K to a Roth IRA, and $30K to the 457 or 403(b). In other circumstances, the tax law would say that the basis of the $20K rolled into the Roth IRA is 40% of $20K, and you would have to pay taxes on remaining 60% of the $20K for 2010 (or split between 2011 and 2012). However, the transfer to the 457 or 403(b) is not permitted to carry any of the cost basis with it, so the entire $20K cost basis remains with the $20K that goes to the Roth IRA. Hence no taxes for the conversion to the Roth!

    Can anyone with a pedigree verify that I have this right?

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