This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

The Non-Deductible IRA Trap -- and the Fix

HUNT VALLEY, Md. ( TheStreet) -- If you don't have any nondeductible IRA assets, this article will not be of interest to you. If you have ever made nondeductible IRA contributions, get ready to be shocked!

Nondeductible IRA assets happen when you are ineligible for an IRA deduction but make an IRA deposit. There is no limitation to make a deductible IRA deposit if you and your spouse (if applicable) don't have a pension plan at work. If you or your spouse has a pension, there are income limitations to deducting IRA deposits. In addition, every year after you make a nondeductible IRA contribution you must file a form 8606 to disclose your basis in an IRA. Here's an example:

IRA
If you have ever made nondeductible IRA contributions, you should start thinking about the lowest-taxed way to get your money out.

Let's say you deposited $5,000 in an IRA with Charles Schwab (SCHW - Get Report) in 2007 and found out it was nondeductible after you filed the form 8606 to disclose your basis. The next year you roll over $95,000 from your former employer's retirement plan to a Fidelity IRA. In 2011 you took the entire amount out of the Schwab IRA and it was still worth $5,000. What is the tax consequence of the $5,000 distribution from the Schwab IRA?

Most would say it is tax free, since there was no tax deduction when it was deposited in 2007, but that is where the problem begins. You must combine all outstanding IRAs as a denominator and use the basis from your IRS-filed form 8606 as the numerator and the percent derived is the only nontaxable portion.

Take our example above. All IRAs outstanding (the denominator), assuming zero growth, is $100,000 ($95,000 at Fidelity and $5,000 at Schwab). The numerator is the $5,000 from the form 8606 basis. This means we have 5% of the $5,000 withdrawn tax free. Therefore $4,750 is taxable and $250 is tax free on any $5,000 withdrawal regardless what account it came from. If you carry that equation through to the end, the nondeductible assets will not be exhausted from that account until the last dollar is withdrawn from all of your IRAs. This could easily be 10, 20 or even 50 years. If someone does not account for the nondeductible assets for the life of the accounts, it may become double taxed when withdrawn.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Try it NOW
Only $9.95
Try it NOW
14-Days Free
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
SYM TRADE IT LAST %CHG
SCHW $30.23 0.00%
AAPL $123.25 0.00%
FB $83.30 0.00%
GOOG $548.34 0.00%
TSLA $185.00 0.00%

Markets

DOW 17,712.66 +34.43 0.19%
S&P 500 2,061.02 +4.87 0.24%
NASDAQ 4,891.2190 +27.8570 0.57%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs