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Dr. Don Taylor, CFA, advice columnist Considering a nondeductible IRA

Dear Dr. Don,
Can I open a nondeductible IRA for my spouse, who is a stay-at-home mom and has no earned income? We do not qualify for either a Roth or a traditional spousal IRA. 
-- Mike Missus

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Dear Mike,
Yes you can. When you say that you're not eligible, I'm assuming that your adjusted AGI exceeds $160,000, the top threshold for both the spousal deductible IRA and the Roth IRA. The IRS Publication 590 explains nondeductible contributions and Individual Retirement Arrangements.

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA of up to the general limit or, if it applies, the spousal IRA limit. The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

The nondeductible IRA grows tax deferred. It's important to file Form 8606 with your tax return in order to be able to later withdraw the contributions without having to pay tax on them.

Making nondeductible contributions doesn't provide a great current tax advantage since you're contributing after-tax dollars to the account and investment earnings will be taxed at ordinary income levels when taken as qualified distributions. Arguably, you'd be better off investing directly in stocks or mutual funds where capital gains will be taxed at a lower rate than ordinary income. Qualified dividend income also gets taxed at a lower rate than ordinary income, at least through 2010.

The nondeductible IRA is an interesting choice right now, since a change in the tax code allows your spouse, in 2010, to convert the traditional IRA to a Roth IRA. Once converted, qualified distributions of the investment earnings will be tax free. A Bankrate article, "Does nondeductible IRA make sense?" explains this strategy in greater depth.

Thanks to David Littell, professor of taxation and the Joseph E. Boettner Research Chair at The American College for his assistance in answering this reader's question.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & investing" or "money."'s corrections policy-- Posted: March 29, 2007
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