In addition to non-taxable contributions to a Traditional IRA (TIRA) – discussed in a previous article – investors can contribute additional after-tax funds to their TIRAs, which can not be deducted from one’s federal tax liability.
Here are few basic points about those types of contributions, as well as few real-life questions about non-deductible TIRA contributions that I encountered working with clients.
Because some of the basic rules listed above might sound complicated or unclear, here are three questions from real clients that might help in clearing up some potential misunderstandings about non-deductible TIRA contributions.
A. You do not need your old 8606 forms. You only need to find the most recently completed form. Since the 8606 form shows the cumulative basis, the most recent form will have the total of all past after-tax contributions to your TIRA or TIRAs – if you have more than one. If you can not find this document in your tax files, you can request a copy by completing and submitting a form 4506 to the IRS. If you have used tax preparation software – such as TurboTax – you could go back to the last tax return and look up the form 8606. If professional tax preparers completed and filed your returns, you should be able to get a copy of the most recent form 8606 from them.
If none of these methods yield results, you can still get the information, but it will require some work on your part. You could go to your IRA custodian and request a history of form 5498s. Since your IRA custodian does not handle your taxes, these forms will NOT indicate whether you deducted these contributions on your tax returns. The only information you will have is that a TIRA contribution was made for that year. You will then have to cross-reference this information against your tax returns to determine whether you deducted the contribution. This method will be time consuming and you must have documentation for your old tax returns.
A. Normally, you would file a form 8606 for each year you make the non-deductible contribution to your TIRA along with your normal tax return. However, the IRS will process a late filed form 8606, even when you file past the normal three-year statute of limitations. Because the form 8606 is a separately signed document, you may file this from without amending your past returns. Therefore, you should obtain an 8606 for each year you made a non-deductible TIRA contribution from the IRS web site and file the completed and signed forms with the IRS. The IRS normally charges a $50 fine for failure to file the form 8606. However, the IRS will most likely waive this fine if you offer a reason for failing to file – even ignorance seems to work most of the time. Filing these forms will establish your TIRA basis for determining how much of your future TIRA withdrawals will not be taxed.
A. There are no tax consequences for accepting the basis of the 401(k) plan as a separate payment. The IRS views this simply as a return of your already taxed dollars to you. Unless there is a specific need for funds, most investors prefer to keep the basis in their rollover. The earnings on the funds will continue to be tax deferred until withdrawn, the basis itself will be part of each withdrawal and will not be subject to tax or penalty in future years. There is no definite guidance from the IRS on how to track this retirement plan basis. Some tax preparers recommend that you should complete and file a form 8606 even though the IRS asks you not to. Filing the 8606 form is the easiest way to keep track of the basis. Other advisors recommend that you keep a copy of the rollover document showing the basis and staple it to the back of the last 8606 filed with the IRS. You can choose any method you prefer, but you need to keep track of these rollover contributions. Otherwise, you might forget about them in the future and wind up paying income tax twice on the same income.
I hope that this information has provided some basic understanding about non-deductible, after-tax TIRA contributions. In the next article I will provide some information about Roth IRA contributions.
Bruce Miller is a certified financial planner (CFP) who also is the author of Retirement Investing for INCOME ONLY: How to invest for reliable income in Retirement ONLY from Dividends and IRA Quick Reference Guide.