Expert: Allen - 3/31/2007

Question
QUESTION: I contributed 5 years $ 20 000 deductable IRA.

I contributed 11 years, $ 22 000 to non deductable IRAs.

My IRAs are currently worth $ 140 000.

When I take distributions how are they taxed?

Is there a difference between the two types of contributions?   


ANSWER: Everything you withdraw from the deductible IRA account will be taxed. This is because no tax was ever paid on either the contributions or the earnings

Only the earnings on the after tax contributions to the non deductible IRA will be taxed. You have already paid tax on the contributions.

If you withdrew everything, you would owe tax on $118,000 and you would not owe tax on $22,000.

---------- FOLLOW-UP ----------

QUESTION: My understanding is that a person only has 1 IRA , or 1 pot so to speak.

How would I determine the taxable part of a withdrawal on say $20 000 for 1 year?

Thank you very much for all your information.

Answer
Your question peaked my curiosity and I did a little research. I have to modify and expand on my answer.

Non deductible IRA contributions are pooled with deductible IRA contributions in the same account. Each year you make a non deductible contribution you are supposed to file Form 8606 with your tax return. When you make a withdrawal you also file Form 8606 with your tax return. The distribution is prorated on a percentage basis between taxable and non taxable amounts. So if you made non deductible contributions of $22,000 and the account was worth $140,000, then 15.7% of the distribution is not taxable and 84.3% is taxable.

The financial institution will report the distribution to the IRS. By filing Form 8606, the IRS will only expect you to pay tax on 84.3% of the amount you received.

If you didn't file Form 8606 when you made the contributions, I would still file one for the years when you make withdrawals.