Traditional IRA Designs

• The Internal Revenue Service regulates IRAs. Part of the regulations include income limits on traditional IRA accounts defining how much you can contribute. As of 2011, the maximum IRA contribution each year is $5,000, or $6,000 for people age 50 and older. If you exceed certain income levels, you can still contribute the full $5,000 (or $6,000), but you might not be able to deduct all of it for tax purposes. If you are unable to deduct the contribution from annual income, that contribution value can be withdrawn tax-free later on. In that way, the nondeductible contributions are similar to a Roth IRA, in which the contributions are not deductible but are not taxable later. However, the Roth allows earnings to qualify for tax-free growth as long as normal distribution qualifications are met.
  
  

Income Limits

• The IRS maintains phaseout ranges for traditional IRA contributions. If you fall below the range minimum, you can make a fully deductible contribution. If your income is more than the range maximum, you cannot take a deduction, though you can make a full contributions. If you are within the range, you must calculate how much you can deduct. Phaseout ranges are reduced if you have an employer's retirement savings plan. There is no income limit for deductions for a single person not covered by an employer's plan. However, if you are covered by employer's retirement plan, the income phaseout range for a single filer is $56,000 to $66,000. A married couple filing a joint return has an income range of $169,000 to $179,000 if there is no employer plan coverage, and this drops to $90,000 to $110,000 if one person is covered by a plan.
  
  

Calculate the Deduction

• It is possible to have your deductible traditional IRA maintain some nondeductible assets. To calculate the deduction, you must use the following formula: Deduction Limit = (Maximum Contribution) x [(Upper Limit of Range - Modified Adjusted Gross Income)/(Upper Limit - Lower Limit)].
  
  Here is an example: John is single, making $60,000 in adjusted gross income annually and is covered by an employer's plan. John makes the full $5,000 contribution. His deduction is calculated as follows: $5,000 x [($66,000 - $60,000)/$10,000]. John can deduct $3,000 of his $5,000 contribution from his taxable income.
  
  

After Your Contribution

• When you have a nondeductible IRA, you must file Form 8606 with the IRS with your personal tax return. This establishes the cost basis of what is taxable later on and what isn't. Nondeductible contributions are not taxable as income upon distribution. For example, if you accumulate $10,000 over time as nondeductible contributions, your proof of this contribution with the IRS is the Form 8606. Everything else about the IRA is the same, whether it is deductible or not. You must reach age 59 1/2 before normal distributions are allowed. Early distributions usually incur a 10 percent tax penalty.