The non-deductible IRA has long been a financial planning tool, albeit one that has become far less popular in recent years, given the tax preferences for both qualified dividends and long-term capital gains.
However, with the new 3.8% Medicare surtax on net investment income that took effect in 2013, a new incentive has emerged: even with ordinary income treatment, the non-deductible IRA provides a way to permanently avoid the surtax, which would otherwise apply to interest, dividends, and capital gains, as well as income from other tax-deferred vehicles like deferred annuities.
The strategy is especially appealing to those who are in the peak income years of their career, where a Roth conversion is unappealing due to the high current tax bracket (and other IRAs that will be aggregated), tax deferral is valuable, and a permanent avoidance of the 3.8% Medicare tax provides yet another added value… especially if the account will hold fixed income investments that were going to be taxed at ordinary income rates anyway.
Fortunately, the strategy is available regardless of how high income rises (and in fact, is best at high income levels), and while the value of the strategy is limited by the IRA contribution limit of $5,500 in
2013 2015, several years of compounded efforts can still potentially produce a significant tax savings in the future!