A nondeductible contribution refers to a type of deposit made into an individual retirement account (IRA) for which the contributor doesn’t receive a tax deduction in the year the contribution is made. Essentially, it means the money you put into your IRA has already been taxed.
This is in contrast to a traditional IRA, where contributions are typically made with pre-tax dollars, meaning the contributions can be deducted from your income, reducing your taxable income for the year and therefore your current tax liability.
Nondeductible contributions are often associated with a type of IRA known as a Roth IRA, which is funded with after-tax dollars. The advantage of making nondeductible contributions and paying taxes upfront is that withdrawals in retirement, including earnings, are typically tax-free, provided certain conditions are met.
However, nondeductible contributions can also be made to a traditional IRA, particularly in cases where a person’s income exceeds the limits for deductible contributions. These contributions to a traditional IRA will not reduce current-year taxable income, but the investment earnings on those contributions will still grow tax-deferred until retirement. When withdrawals are made during retirement, the previously taxed contributions can usually be withdrawn tax-free, but the earnings will be subject to income tax.
It’s important to keep track of nondeductible contributions to avoid double taxation when the money is withdrawn. IRS Form 8606 is used to keep a record of this.