A New Benefit for Non-Deductible IRA Contributions

A New Benefit for Non-Deductible IRA Contributions

There are a number of tools you can use to reduce taxes on the growth of your investments. You can contribute to a traditional IRA, where you get a tax deduction for the contribution plus tax-deferral on all gains until you retire. Or you can contribute to a Roth IRA. You don’t get the tax deduction but you do get complete tax-free growth, not only over your lifetime but over your heirs’ lifetimes as well. Annuities are another way to get tax-deferred growth. You can even purchase stocks, ETFs, or mutual funds in ordinary taxable brokerage accounts and get a break on the tax rate for qualified dividends and long-term capital gains. However, there are restrictions on the tax benefits for most of these options. In the case of traditional IRAs, if you or your spouse is a participant in a retirement plan at work and/or your income is high enough, you lose the deductibility of the IRA contribution. That limitation has made non-deductible IRA contributions much less popular than most other tax-beneficial choices.

Starting this year the new 3.8% Medicare surtax on net investment income kicks in as part of the Affordable Care Act. And the tax code excludes IRAs and 401(k)s (among other types of accounts) from having to pay this tax on withdrawals. As a result, non-deductible IRA contributions represent a new strategy for high-income taxpayers to proactively avoid this new tax. If your income and/or participation in a company 401(k) prevents you from making Roth or deductible IRA contributions, not only will non-deductible IRA contributions allow you to permanently avoid the 3.8% tax, they also enable you to defer taxes on any investment gains until you retire, when your marginal tax rate presumably will be lower. Of course, with a $5,500 contribution limit per year (or $6,500 if you are age 50 or over), you won’t be sheltering a lot of your income. Nonetheless, every little bit helps.

Michael Kitces in his Nerd’s Eye View blog explains this strategy in more detail. Here’s the link: http://www.kitces.com/blog/archives/451-Will-The-New-3.8%25-Medicare-Surtax-Reinvigorate-Non-Deductible-IRA-Contributions.html.

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