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If your AGI puts you in the in the "partial deduction" or "no deduction" category for IRA contributions, can you still contribute up to $5,500 (2018) without penalty? Is it still advantageous to do that vs putting the funds in a fully taxable account?

  • Note that you only have an income limit for deducting Traditional IRA contributions if you or your spouse were "covered" by a retirement plan at work that year (e.g. if you or your employer contributed to your 401(k) during the year). If not, you can deduct Traditional IRA contributions no matter how high your income is. – user102008 Oct 12 '18 at 15:43
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Yes, you can contribute up to $5500 to your Traditional IRA without penalty, as long as you make at least $5500 of income that year. There is no income limit for contributing to Traditional IRA, so contributing $5500 is not an "excess contribution" no matter how high your income is. Since you cannot deduct it, it will be a "non-deductible" Traditional IRA contribution, and will need to be reported on Form 8606. The amount of non-deductible contributions you have made forms the "basis" (after-tax amount) of your Traditional IRA, and when you withdraw, the part of the withdrawal that is after-tax is not taxed.

Keeping after-tax amounts in Traditional IRA long-term is worse than either Roth IRA (since the earnings are still pre-tax in a Traditional IRA, but earnings are after-tax in a Roth IRA) or pre-tax amounts in Traditional IRA (since you paid tax once for after-tax contributions, but you will pay tax again on the pre-tax earnings made from those after-tax contributions when you withdraw). Whether it is better or worse than a taxable account depends on the specific details of how that taxable account is taxed.

However, non-deductible Traditional IRA contributions are very useful as an intermediate step in "backdoor Roth IRA contributions". This is for people whose incomes are too high to contribute to Roth IRA (since Roth IRA, unlike Traditional IRA does have income limits for contributions). Instead, they contribute to Traditional IRA and then immediately rollover that amount into Roth IRA (both of these steps do not have income limits). Assuming they had no pre-tax money in Traditional IRA that year, the result is basically the same as a regular Roth IRA contribution.

  • "Keeping after-tax amounts in Traditional IRA long-term is worse than either Roth IRA… or pre-tax amounts in Traditional IRA" True, but still better than a taxable account because it grows tax-free. – Kevin Oct 11 '18 at 20:46
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    Sounds like my best best is to step through the Traditional IRA to my ROTH account, thanks! – Aaron McMillin Oct 11 '18 at 21:02
  • @Kevin: No, it's worse than a taxable account, because gains in a Traditional IRA are taxed as income (at the time of withdrawal), which is a higher rate than capital gains and qualified dividends. – Ben Voigt Oct 12 '18 at 1:06
  • @BenVoigt If you are 100% invested in things that do not give dividends, this is true. If you are invested in things that give dividends, I think you'd have to do the math. – Eric Oct 12 '18 at 12:32
  • @BenVoigt Any references for IRA taxed as income vs capital gains in "regular" account? First time I'm really hearing of that concept. – Aaron McMillin Oct 12 '18 at 16:14

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