What to Do When Your IRA Contribution Isn't Deductible

Once you master the basics of retirement planning and saving, you may want to consider different tax implications.

A traditional IRA is often a good idea for those who want to help lower their current tax rate. However, that depends on whether your IRA contribution is deductible. If you or your spouse have an employer-sponsored plan and exceed certain income levels, it may not be.

In that case, you may want to consider either a Roth IRA or a taxable account. Contributions to a Roth IRA are never tax-deductible, but qualified distributions at retirement are tax-free. Learn more about Roth IRAs here.

What if your income is too high to contribute to a Roth IRA and you aren’t eligible to deduct a traditional IRA contribution? You can still take advantage of a Roth by opening a traditional IRA with nondeductible contributions and then converting the traditional IRA to a Roth, since there's no income limitation on Roth conversions. If you’ve made only nondeductible contributions to the traditional IRA, you’ll owe taxes only on the earnings in the account at the time of the conversion. See the segment on conversions and recharacterizations below.

Taxable accounts offer several potential benefits:*

  • Unlike employer-sponsored retirement plans and IRAs, there's no annual maximum contribution amount.

  • There are no required minimum distributions—you can take out the money (or not) whenever you please.

  • Taxes generally aren’t due until you sell the investment (exception: certain short-term dividends issued by mutual funds may be taxable to you each year).

  • If your investment grows and you've held it for at least a year before selling, it will be subject to the long-term capital gains tax, which is generally lower than ordinary income tax rates.
  • If you sell your investment at a loss, you may be able to offset any capital gains up to $3,000 in a tax year. And, you can carry forward losses to future years. This helps lower the amount of taxes you may owe.

  • When you leave taxable accounts to your heirs, they generally benefit from a step-up in tax basis. That means they'll pay capital gains tax only on the appreciation from the time of your death until they sell, rather than on the appreciation that occurred during your lifetime. When you leave traditional 401(k)s and IRAs to beneficiaries, they must pay ordinary income tax on distributions.

A Financial Advisor can help you explore the investment opportunities available in taxable accounts.

*Source: IRS.gov. Note that neither Navy Federal Credit Union nor any of its affiliates give tax advice. Discuss your particular situation with a tax advisor or attorney.

IRA Conversions and Recharacterizations

You may have heard of IRA conversions, “back-door Roths” and recharacterizations, but what do they mean? Conversion refers to the transition of a traditional IRA to a Roth IRA, and recharacterization refers to changing a Roth IRA back into a traditional IRA. Both of these actions involve specific rules and tax implications.


Converting a traditional IRA to a Roth IRA can be a smart tax move that will save money in the long run. Keep in mind that you’ll have to pay ordinary income taxes on the amount of the conversion. However, qualified distributions in retirement will be tax-free. You may want to consider a conversion if:

you prefer to have some tax-free income in retirement

you anticipate a significant drop in income in a particular year, but increasing income in later years. In that case, a conversion could be done in the year you’re in a lower tax bracket. 

your investment values have dropped temporarily and you anticipate future appreciation, so you’ll pay taxes on a lower account balance if you convert now 

a tax increase is announced by the government for a future year, so a conversion before the increase may save on taxes

you cannot deduct traditional IRA contributions and make too much money to open a Roth

A conversion may also be referred to as a “back-door Roth.” That’s because while there are income limits to be eligible to open and contribute to a Roth IRA, there's no income restriction for converting to a Roth. So you could make a nondeductible contribution to a traditional IRA and then immediately convert it to a Roth IRA.

Before converting your existing IRA to a Roth IRA, take time to speak with a tax advisor to understand all the potential taxes that could be due. Identify any non-IRA funds you have at your disposal to cover any tax liabilities—that way the funds you convert can continue to grow tax-free.*


Recharacterization allows you to “unconvert” a Roth IRA, returning it to a traditional IRA without IRS penalties. (You may also recharacterize a conversion from an SEP and employer pension/profit-sharing plan.) A recharacterization must be done before the tax filing deadline, plus extensions.

Some reasons to consider a recharacterization include the following:

  • The investment value in the Roth IRA has dropped. In that case, you may have overpaid taxes on the conversion.

  • The income from the conversion has bumped you into a higher tax bracket.
  • You think you’ll be in a much lower tax bracket when you retire.
  • You don’t have enough money to pay the taxes due.

If you change your mind again, you may be able to reconvert the traditional IRA back into a Roth. Talk to a tax advisor about the best route for your situation.

*When converting your IRA, you're required to report the amount of previously deducted contributions and dividends since they haven't been taxed. Conversions are reported as a distribution from the traditional IRA and as a conversion to the Roth IRA. If you withdraw any of the assets you converted from a traditional or simplified employee pension (SEP) to a Roth within the first 5 years following your conversion, you may pay a 10 percent penalty on the amount withdrawn, regardless of age.


If you've maxed out your contributions to your IRA and employer-sponsored plans, an annuity may be an investment option that can help you round out your portfolio.

The Basics

An annuity is an insurance contract designed to provide retirement income. You, as the annuitant, pay the annuity issuer, who later pays out the principal and earnings back to you. It's important to investigate the financial strength of the company.

The term “annuity” refers to a stream of payments guaranteed for some period of time—for the life of the annuitant, until the annuitant reaches a certain age or for a specific number of years, among other options.

There are 2 phases of an annuity:

  • Accumulation: When money is added to the annuity, either as one lump sum (a single premium annuity) or as periodic payments to the insurance company.

All guarantees are made by the issuing insurance company and are subject to the company's claims-paying ability.

  • Distribution: When you begin receiving distributions from the annuity either as lump sums or as a guaranteed income stream for your lifetime or a set period of time.

Annuity Options

When choosing an annuity, the first thing you need to do is determine the timing of payout that is best for you. There are two options:

  • Immediate annuities: Distributions begin immediately upon investing. With an immediate annuity, you can choose from several options for receiving payments, such as a certain period of time or for the rest of your life. You can also choose between a fixed payment and a variable payment based on market performance. Immediate annuities are best suited for someone near retirement age who perhaps hasn’t saved enough and needs a steady supplement to Social Security and other investments.

  • Deferred annuities: With a deferred annuity, you deposit your money with an insurance company and let it grow tax deferred until the date set in your contract. A deferred annuity also allows you to choose between fixed or variable payouts. Deferred annuities are best suited for someone under age 40, as investments in these securities usually require 15 or 20 years to reach a return rate above other low-risk investments.

The next decision is to choose the investment type that works for you:

  • Fixed: Fixed annuities offer a guaranteed rate of return. The insurance company invests your premium in its general account. Whatever payout option you select, the interest gains and payment amounts are guaranteed by the insurance company, which assumes the risk of investing the general account.

  • Variable: With a variable annuity, you choose the investment, and your payout will depend on the performance of the underlying securities in the separate accounts in which your premium is invested. Unlike fixed annuities, the value of your account isn't guaranteed—you assume the risk involved in investing your premiums in exchange for potentially higher returns.

  • Indexed: The insurance credits you with a return that's based on changes to an index, such as the S&P 500.

Real Estate as an Investment

Investing in real estate can add diversity to your portfolio. Like any investment, it offers potential risks and rewards. Here are a few ways to take advantage of the real estate market:

Buy rundown houses, fix them up and sell at a profit. Also called “flipping,” this can be a high-risk, high-reward endeavor. If you don’t have cash to buy the property, you’ll need to borrow it. Then you’ll have to pay for renovations (or do them yourself). If the market isn’t favorable, you may not get back your investment. However, in a high-demand area, you may earn a profit.

Become a landlord. In this case, you buy homes, apartments or commercial buildings and rent them out. As long as the market is favorable, you may be able to count on a steady stream of income. The potential downside: you have to maintain the property and deal with tenants, who may or may not be responsible renters.

Real Estate Investment Trust (REIT). Instead of owning property directly, you may consider buying shares in a REIT. REITs work somewhat like mutual funds, but instead of stocks, REITs invest in a portfolio of properties, and just like mutual funds, the value of your REIT isn't guaranteed. They may include residential, commercial, industrial or health care properties, depending on the REIT sector. The performance of the REIT depends on cash flow from the properties and gains/losses from property sales, as well as costs involved with maintenance and administration. 

If you decide to invest directly in real estate, be sure you do your research. You’ll want to explore local property values, taxes, potential assessments and renovation costs. If you're considering a REIT, a Financial Advisor may help you explore suitable choices.

Considering Early Retirement

Many of us dream of retiring early. With diligent saving and budget control, it’s possible! In fact, there are many websites dedicated to frugal living with stories of those who’ve saved early and often to achieve financial independence early in life. If you’re thinking of early retirement, consider the following:

Will you be emotionally ready to retire? For those whose identities are closely tied to their work, leaving a job can be challenging. If that sounds like you, you might pick up a hobby-related part-time job or start a business after you’ve reached your goal.

Have you calculated how much money you’ll need to save? According to TheMilitaryWallet.com, a military pension could cover about 50 percent of your basic pay. However, that leaves another 50 percent for you to come up with each year of retirement—perhaps more depending on your desired retirement lifestyle. If you won’t receive a pension, you’ll need to save enough to cover up to 100 percent of your pre-retirement income. 

When will you apply for Social Security? You can apply as early as age 62, but will face a permanently reduced benefit if you take benefits before your full retirement age (66 to 67, depending on your birth year).

What will you do for healthcare coverage before you reach Medicare eligibility? If you’re career military, you can count on lifetime healthcare, but if you aren’t, you may need a private plan to bridge the gap.

Do you have hobbies and interests to keep you busy?

Do you have a good social network outside work?

What about your spouse or partner? What happens if he or she continues to work while you’re retired?

When will you create a retirement budget?

Do you have enough retirement savings to provide sufficient income for the number of years you expect to be retired?

If early retirement is your dream, you’re on track to make it happen by planning ahead and saving and investing wisely.

Section Complete! Here's how you did: