This is a great question, with several layers to make our way through. First, every dollar made to an IRA is technically “after-tax.” For example, a $5,000 contribution to a Traditional IRA would come from after-tax money an investor assumptively made through their job. However, the question is deductibility - can an investor deduct their contribution to reduce their taxable income for the year?
Most people with earned income (a requirement for any IRA contribution) are able to make tax-deductible contributions to Traditional IRAs. However, there are cutoffs for some investors. Let’s place this concept into two categories.
Investors without access to a qualified plan
As you’ve learned in the material (in both the SIE program and the Series 7 program), qualified plans are employer-sponsored retirement plans governed by ERISA. When an investor does not have access to a qualified plan through their work, they generally speaking can deduct 100% of their contributions up to the contribution limit.
Investors with access to a qualified plan
When an investor has access to a qualified plan (e.g. a 401k or 403b), the IRS is a little more stringent with deductibility rules. Contributions can usually be fully deducted as long as income levels don’t exceed these levels:
Single filer: $65,000
Married filing jointly: $104,000
If an investor reports income lower than these levels, they may always deduct 100% of their Traditional IRA contributions. Once income exceeds these levels, the deductibility starts going down, eventually getting to a point where no deduction may be made. If you’re interested in the actual numbers and specifics, here’s a link to the IRS page on this topic.
Investors with higher earned income levels may always contribute to a Traditional IRA, but may not be able to deduct their contributions. If that’s the case, they must file Form 8606 annually to keep track of their “basis” (a.k.a. “after-tax” money in the IRA that was not deductible). As you said in your post, the benefit is the after-tax growth. The basis will never be taxed at distribution, but the growth will be.
A few other points - first, Traditional and Roth IRAs are not considered qualified (although lots of financial professionals refer to them as qualified). Qualified means two things - first, the plan is ERISA compliant, and second, the IRS has approved the plan. They are also always workplace plans. Traditional and Roth IRAs are not subject to ERISA regulations, are not IRS approved, and are not employer-sponsored (investors simply start them on their own). Therefore, they’re not qualified, even though a Traditional IRA works similarly to a 401k (from a tax perspective). SEP and SIMPLE IRAs are ERISA governed and IRS approved, and therefore are qualified plans.
Phew - that was a lot! I hope this helps!