After Tax Contributions to Traditional IRA

Last update on: May 28 2020
By Bruce Miller
IRA

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.

  1. There is no Adjusted Gross Income (AGI) limit or any other constraints to making non-deductible contributions to ones TIRA. The only requirement is that the TIRA owner or their spouse has a minimum compensation income that is equal or that it exceeds the amount of the TIRA after-tax contribution.
  1. The individual investor must report all after-tax contributions to the TIRA on form 8606 for the year of contribution. The 8606 is a cumulative form that shows total after-tax dollars that have been contributed to the TIRA over the years.
    1. The IRA owner must keep the most recently filed form 8606 indefinitely as that is the only record of after-tax contributions. Make a copy of the most recent form 8606 and keep with your will. That way if you die, your heirs will know that the withdrawals they must take will be partly tax free.
    2. The 8606 form is NOT filed for contributions to ones Roth IRA (RIRA) or for deductible contributions to ones TIRA.
  1. The cumulative after-tax contributions are called the “basis”. This contribution represents the after-tax – non-deducted – part of the IRA and is comparable to the RIRA basis.
  1. Contributing after tax funds to one’s TIRA means that part of the value of the TIRA will be after tax and part will be pretax.
    1. Future distributions from a TIRA with basis will be proportioned between the basis and the pretax value of the TIRA.
    2. There are rare cases where funds in a TIRA will be subject to taxation or a direct rollover from a retirement plan where some of the dollars in the transferred retirement plan were after tax – such as interest paid on a retirement plan loan or the mortality expense on life insurance. However, neither of these two cases forms the basis in the IRA. I will discuss Unrelated Business Taxable Income (UBTI) further in a future article about all potential tax issues with IRAs.
  1. Some employer-sponsored retirement plans allow employees to make after tax contributions to the plan that will form the basis in the plan.
    1. When these plans are rolled over to the former employee’s TIRA, the transfer document should show the amount of the rollover that is basis.
    2. The TIRA owner must track any basis separately and include it with the most recent form 8606 basis amount to determine what percent of a future withdrawal will be basis – not included as income – and what percent of the withdrawal must be included as income.
      1. Some 401(k) plans that allow after tax contributions will segregate these and treat them as separate accounts. These plans will keep the after-tax contributions and their own earnings separate from the pretax contributions and their earnings.

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.

 

Non-deductible Contributions to a TIRA Q&A

Q.  I will be making my first annual withdrawal from my TIRA this year, which is my first year of retirement. My tax preparer asked me if I have made after-tax contributions to my TIRA in the past, which I know I have. She said that I will need to show her my form 8606 so that she can determine how much of my TIRA withdrawal will not be taxed. How do I find my old 8606 forms?

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.

Q.  I’m single and my AGI has been over $150,000 for many years, so I have been making non-deducted contributions to my TIRA. However, I didn’t know I was supposed to complete a form 8606. What can I do to correct this?

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.

Q.  After I left my last employer, I received an account statement for my 401(k) that showed I had about $7,000 in after-tax contributions in my 401(k). On my rollover request, the plan gave me the option to get a separate check for this after-tax amount or to include it in the rollover. Is there any tax or penalty for taking the check directly and how do I track this in my TIRA?

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

 

 

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.

December 2020:

Congress Comes for your Retirement Money

A devastating new law has just been enacted, with serious consequences for anyone holding an IRA, pension, or 401(k). Fortunately, there are still steps you can take to sidestep Congress, starting with this ONE SIMPLE MOVE.
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