Some people may even end up paying taxes twice. Your ability to fund different types of IRAs is subject to restrictions based on your income, your tax-filing status, and your eligibility to participate in an employer-sponsored retirement plan, even if no contribution has been made to the plan in a given tax year. For example, you can make additions to a tax-deductible, non-deductible, or Roth IRA account in a given tax year, as long as the combined contributions do not exceed the limit. If your income excludes you from the Roth option, you can simply contribute to a non-deductible IRA and then convert it to a Roth IRA.
Contributing to a non-deductible IRA on the way to a clandestine conversion to Roth could be a great way to protect some or all of your retirement savings from taxes. In a Roth 401 (k) plan, employees contribute after-tax money to a designated Roth account within the 401 (k) plan. In a Roth conversion, pre-tax IRA dollars are taxable income for the year, converting the money into Roth dollars. Many people who don't qualify to fully fund a deductible IRA or a Roth IRA miss out on this easy opportunity to save additional money for retirement, allowing them to grow tax-free.
For example, since you've already paid income taxes on this money, you can usually convert it into a Roth IRA where profits increase without paying taxes. When you turn 72, the IRS requires you to add up the value of all your deductible and non-deductible IRAs and begin receiving distributions from your traditional (but not Roth) IRAs. In a clandestine Roth, investors make a non-deductible contribution to a traditional IRA and then quickly convert it to a Roth IRA. Non-deductible contributions to an IRA don't provide an immediate tax benefit because they're made with after-tax money, such as a Roth IRA.
Your IRA depositary can send you a statement of how much you need to withdraw, but it's best to have it done by a tax advisor, who can also help you determine what part of your RMD is taxable if it includes non-deductible contributions. And unlike a Roth IRA, deductible and non-deductible IRA contributions can be combined in the same account. If your contribution to a Roth IRA is limited, use the IRS Publication 590-A worksheet to help you determine your contribution limit. If you still want to keep non-deductible IRA contributions without converting them immediately, you should keep that cash separate from any IRA that has pre-tax contributions, O'Mara said.
Contributions to a Roth IRA are never tax-deductible, but in return, your retirement distributions are tax-free. If you earn too much to contribute to a Roth IRA or to make deductible contributions to a traditional IRA, you can still make non-deductible contributions to a traditional IRA.