When to Make Nondeductible IRA Contributions

The contribution limit for IRAs has been inching up in recent years. As a result, you may want to contribute to an IRA if your career is just getting off the ground or to supplement your 401(k) or other employer plan. However, be forewarned: You may not be able to—and probably can’t—deduct all of your IRA contributions for 2023.

Nevertheless, you might decide to contribute to an IRA on a nondeductible basis. Although the contributions won’t reduce your current tax liability, the amounts continue to grow without any current tax erosion within your account. And, when you’re finally ready to withdraw funds in retirement, the savings may be greater than you might think.

When should you begin to make nondeductible contributions to your IRA? The sooner you get started, the better.

Here are the main facts you need to know. For 2023, the maximum contribution allowed is the lesser of 100% of your earned income for the year or $6,500, an increase of $1,000 from 2022. What’s more, if you’re age 50 or older, you can kick in an extra “catch-up contribution” of $1,000 for a grand total of $7,500, up from $7,000 in 2022.

The $1,000 limit for catch-up contributions was set statutorily. However, under the new SECURE 2,0 law, the IRA catch-up contribution limit will be indexed for inflation, beginning in 2024. This indexing will occur in increments of $100.

Key point: If you participate in an employer retirement plan and your AGI for 2023 exceeds an indexed a threshold—$136,000 of modified adjusted gross income MAGI) for joint filers and $83,000 of MAGI for single filers in 2023—you can’t deduct any part of your IRA contributions. (Partial deductions may be allowed for a lower MAGI.) Despite this drawback, if you contribute the maximum amount to an IRA this year, next year, the year after and so on, you will have a tidy sum saved up by the time you’re ready to retire.

For example, say that you are a 401(k) participant who turned age 50 this year, you’re single and your annual MAGI is $100,000. Therefore, you can’t deduct IRA contributions. However, you still make contributions to an IRA for the next 15 years, beginning in 2023. For simplicity, assuming an annual 7% return on a contribution of $7,500 year, you will accumulate $188,468 for retirement in addition to the savings in the 401(k).

Of course, the distributions from the IRA are taxable, but it’s likely that you will be in a lower tax bracket when you begin taking payouts. So you’re still way ahead of the game.

Alternatively, you might contribute to a Roth IRA. The annual limits for Roth IRAs are the same as the limits for traditional IRAs. With a Roth IRA, distributions during retirement are generally tax-free. However, the ability to contribute to a Roth is phased out for higher-income taxpayers.

Consult with your professional advisors concerning the best strategy for your situation.