What Is the Difference Between a Roth IRA and a Nondeductible IRA?

by kristine on December 4, 2010

What is a nondeductible IRA?

The two main types of IRAs are traditional IRAs and Roth IRAs.  Traditional IRAs were created back in 1974 to allow people who didn’t have company retirement plans to save for their retirement in a tax-deferred account.  Roth IRAs were added in 1997; the main difference between the two types of IRAs is that you don’t get a tax deduction for contributions made to a Roth IRA; instead you get to take qualified withdrawals tax free.    We’ll discuss each type of IRA in more detail, including the difference between Roth IRAs and nondeductible IRAs.

Traditional and Nondeductible IRAs

Traditional IRAs allow people to set aside money for their retirement in a tax-deferred account.  Generally, people who contribute to traditional IRAs take a deduction on their tax return for the contributions made.  Thus, they are getting a tax break now, but they will pay taxes on the withdrawals they take out of the IRA later.

However, some people who make traditional IRA contributions may not be able to deduct them.  If you are participating in a retirement plan through work (401K, 403B, etc.) and your modified adjusted gross income is above the amount(s) listed below, then your deduction will be limited or even eliminated completely.

If you participate in a company sponsored retirement plan your IRA contributions may not be deductible if:

  • You are a Single taxpayer and you have adjusted gross income above $55,000; your deduction is completely phased out at $66,000, or
  • You are filing as Married Filing Joint with your spouse and your income is above $89,000; your deduction is phased out completely once your income exceeds $109,000.

If you do not have a company retirement plan but your spouse does, then you can contribute to a traditional IRA, but your deduction will be limited if your combined adjusted gross income is above $167,000, and you will not be able to deduct any of your contributions if your income is greater than $177,000.

Roth IRAs

In addition to traditional and nondeductible IRAs, we also have Roth IRAs.  The main difference between a Roth IRA and a traditional IRA is that Roth IRAs grow tax free.  Contributions made to a Roth IRA are not deductible, but Roth IRA withdrawals (as long as they are qualified) are not taxed.  Some of the advantages of a Roth IRA include:

  • Earnings in a Roth IRA grow tax-free and may be taken out of the Roth IRA tax and penalty free once you reach age 59 ½ or if you meet some of the other qualifying distribution rules.
  • Your contributions to a Roth IRA can be taken out tax and penalty free at any time for any reason.
  • Up to $10,000 in earnings can be taken out of your Roth IRA tax free to be used for purchasing a home (must qualify as a first time homebuyer)
  • Inherited Roth IRAs keep their tax free status, so this is a great way to pass tax free income to children and other heirs.

What’s the Difference between a Roth IRA and a Nondeductible IRA?

At this point, you may be thinking that Roth IRAs and nondeductible IRAs look pretty similar.  And you’d be right, there are some similarities, most notably the fact that your contributions are not deductible in both a nondeductible IRA and a Roth IRA.  But there are some differences too.  The main difference is the way the earnings are taxed.  With nondeductible IRAs, your contributions will not be taxed when you take them out (since you did not get to take a deduction for your contributions) but your earnings will be subject to tax.  With a Roth IRA, neither your contributions nor your earnings will be taxed with you withdraw them (assuming you take qualified distributions).

Which is Better: a Roth IRA or Nondeductible IRA?

As you can see above, the ability to take both contributions and earnings out tax free gives the Roth IRA a clear advantage over the nondeductible IRA.  However, if you can’t contribute to a Roth IRA because your earnings are too high, then a nondeductible IRA may be a good alternative, especially since you may be able to convert the nondeductible IRA to a Roth IRA at a later date.

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