Non-deductible (after tax) tIRA Contributions

[Delawaredave5]

Years ago, before Roth IRA's existed, there were several years where I made nondeductible, after tax, traditional IRA contributions.

I'm just investigating, but had some questions if someone has gone down this road recently...

1. Basis: When I look at account in Fidelity, I see a "basis" - I'm assuming that's total contributions - I was hoping to see segregation of "before tax" contributions and "after tax" contributions.

2. For after tax, non-deductible contributions: Can these be extracted and moved to Roth IRA paying no tax ?

If these after tax, non-deductible contributions cannot be moved to Roth, when I withdraw these from tIRA, I don't pay tax on these contributions again, do I ?

Thanks !

http://www.irs.gov/pub/irs-pdf/i8606.pdf

 

[LOL!]

1. One is supposed to file Form 8606 in years that one makes non-deductible tIRA contributions in order to help the IRS and you keep track of your cost basis.

2. One cannot simply converted the non-deductible contributions to a Roth IRA. Any conversion is done on pro-rated amounts for IRAs, so any conversion will use some of the contributions and some of their gains, thus taxes will need to be paid on the gains portion.

However, I think one can move the tIRA to a 401(k) and launder the money a little bit if one has a 401(k) that accepts such rollovers. The rules for 401(k)s are little bit different when it comes to pre-tax and post-tax rollovers.

For more info, look up Backdoor Roth IRA.

 

[kaneohe]

The term basis is confusingly used in different ways:
1) cost basis in taxable accounts is used mean how much you paid for something. You use it for figuring your gains.
2) basis in TIRA is meaningfully used to mean your non-deductible contributions. However since the fund company generally has no knowledge of whether your contribution is deductible or not (depends on your tax situation and even you may not know when you make the contribution), you must keep track w/ your 8606. Funds use the cost basis number perhaps to remind you
as in taxable investments how good you are as an investor....but, unlike a taxable account, this number is not related to taxes you will pay when funds are withdrawn.
3)to add to the confusion, basis in Roth IRA is meaningfully used to mean your original contributions and also your conversion contributions which you also should track (on the side since there is no IRS form to do that).....and like the TIRA, fund companies sometimes track your cost basis (price you paid) like in the TIRA just to make you feel bad if your funds went down.

 

[pb4uski]

And all of that is why I decided that non-deductible contributions were not worth the bookeeping hassle that they created.

 

[Delawaredave5]

Thanks. Hopefully I filed 8606 back in years I did after tax tIRA. If a Roth conversion has to be prorated I don't want to do because majority is pretax and I'd pay too much in taxes for conversion.

Interesting idea of IRA to 401k - I'll research more - I'd be surprised my 401k plan would accept "non pay contributions".

How to Roll Over Traditional IRA to 401(k) Without Tax Penalties | Finance - Zacks

 

[Sunset]

I think the IRA to 401K would be bad to do, as then all of it becomes taxable upon withdrawal.

Normally I believe folks just pro-rate their IRA withdrawl each year by (total taxable contributions/total amount).
And adjust it each year as it changes (and some is withdrawn each year).

Would be much better to be able to split it off into a Roth.

 

[kaneohe]

I think the IRA to 401K would be bad to do, as then all of it becomes taxable upon withdrawal.

typically 401Ks don't accept basis anyway.

 

[jim584672]

Once you have non-deductible contributions in a tIRA you are in form 8606 hell for eternity.

 

[jebmke]

Form 8606 is not particularly onerous. They have a handy instruction guide for completing it.

http://www.irs.gov/pub/irs-pdf/i8606.pdf

 

[sheehs1]

I made the same type of contributions to a nondeductible IRA for several years with the intent of converting it to a ROTH when or if I ever was able to do so and probably for the same reasons you did. (1) Another way to grow tax deferred (2) other than a Simple IRA contribution it was the only other mechanism I had to defer taxes on growth and/or income.

Imagine my surprise when I was told I could not just convert it and pay no tax. Hey, I already paid tax on that money, right? Wrong. It had to be combined with the total of all of my IRA's and a tax calculated on it. There was nothing I had read prior to making these deposits that "spoke" about the withdrawal/conversion pieces of a nondeductible…at least not that I recall.

I still haven't given up the possibility of getting rid of the nondeductible IRA and converting it to a ROTH and will be looking at the tax consequences again this year. I won't be making any additional deposits to it…that is for sure. For me, it is about 13% of my deferred accounts. Doesn't seem to makes a lot of sense to take after tax money and have it's basis figured into a tax situation.

 

[karluk]

Once you have non-deductible contributions in a tIRA you are in form 8606 hell for eternity.

"Eternity" may be an exaggeration, but not by much. But for me it was much shorter, and at least I knew ahead of time the consequences of making non-deductible IRA contributions. Money magazine and other financial sources covered the 8606 reporting requirements in great detail at the time I was considering this move.

I ended up with a mixture of deductible and non-deductible contributions in my traditional IRA. When Roth IRAs became available a few years later, I systematically converted all of my tIRA to Roth over the next few years. It wasn't particularly complicated - I just had to refer back to old 8606 forms to figure my taxable amount. After the conversions were completed, I was free of 8606 forms, hopefully forever. Naturally this is only a feasible option for people who aren't boosted into a higher tax bracket by the conversions.

The one wrinkle I remember from back then was in the years I was eligible for a mixture of deductible and non-deductible contributions. There was a calculation that showed me what my maximum deductible contribution was, but there was no requirement to actually take the maximum deductible contribution. What I would do is figure my taxable income based on the maximum, then go back and reduce the maximum by some small amount - just enough to avoid going to the next line in the tax tables. Since the tax tables go in $50 increments, I was generally able to reduce my deductible contributions by $20-$30 without increasing my taxes. I figured (correctly) that it would save me a little money upon withdrawal or conversion to Roth.

Anybody else would figure that the money saved is too trivial to be worth the effort and that I was just exhibiting the OCD side of my personality. True enough, but I was proud of using the tax laws to my advantage and getting the utmost benefit out of my tax situation.

 

[Alan]

Once you have non-deductible contributions in a tIRA you are in form 8606 hell for eternity.

If you plan correctly, knowing the pitfalls, then it may not be quite so bad.

I made non-deductible IRA contributions up to the year I retired, then I converted it all to a ROTH and paid tax, at a lower tax bracket now I was retired, on the gains.

The following year I did a rollover of my 401k to a tIRA leaving me with no basis to track. The pitfall is doing a 401k rollover to a tIRA before starting the ROTH conversions because as mentioned above only a portion of the basis is converted, and you continue to have 8606 forms until all the tIRA money is converted to a ROTH.

If the gains on the non-deductible had been large enough to move me up a tax bracket then I would have taken a couple of years converting it to a ROTH before rolling over the 401k

 

[GrayHare]

Keep in mind the longer one leaves after-tax dollars in a tIRA, the more ordinary income tax accumulates on their earnings. Those same dollars inside a Roth (or, as some prefer, a "Retirees Owe Taxes, Ha!") account earn tax free money. Decades of compounding can grow a significant difference in taxes.

 

[doughroller]

At the risk of hijackiing this thread, what is the consensus on this forum on non-deductible traditional IRA vs. taxable investing? My take, illustrated by this thread is that bookkeeping tends to be a PITA.

 

[karluk]

Keep in mind the longer one leaves after-tax dollars in a tIRA, the more ordinary income tax accumulates on their earnings.

I usually try to support my opnions with concrete calculations, but this time I'll go out on a limb with a glittering generality - converting nondeductible tIRA contributions to Roth is always a win, whereas converting deductible contributions and earnings can be good or bad, depending on tax brackets at the time of conversion and time of withdrawal.

It seems to me that the net result is that having a mixture of deductible and nondeductible contributions provides an incentive for making the conversion immediately, rather than waiting for a lower tax bracket in retirement. The conversion benefits from being only partially taxable and all future earnings will be tax free.

Assuming this reasoning is correct, it's still necessary to run some trial scenarios to find the break even point where the benefits of getting some post tax money into the Roth balances the higher taxes on the pretax money being converted. This appears to be a fairly complicated subject.

 

[Alan]

Not saying this is better or worse but back in the days I was working I chose to max out my tax deferred 401k before making non-deductible IRA contributions, and if backdoor ROTHs had been in existence then I would have been converting it straight to a ROTH. (I always made too much for deductible IRA's to be an option)

Back then I was never savvy enough to explore the possibilities of the money being more tax efficient in after tax funds where cap gains were only going to be taxed at 15% or whatever in retirement.

 

[Sunset]

I made the same type of contributions to a nondeductible IRA for several years with the intent of converting it to a ROTH when or if I ever was able to do so and probably for the same reasons you did. (1) Another way to grow tax deferred (2) other than a Simple IRA contribution it was the only other mechanism I had to defer taxes on growth and/or income.

Imagine my surprise when I was told I could not just convert it and pay no tax. Hey, I already paid tax on that money, right? Wrong. It had to be combined with the total of all of my IRA's and a tax calculated on it. There was nothing I had read prior to making these deposits that "spoke" about the withdrawal/conversion pieces of a nondeductible…at least not that I recall.

I still haven't given up the possibility of getting rid of the nondeductible IRA and converting it to a ROTH and will be looking at the tax consequences again this year. I won't be making any additional deposits to it…that is for sure. For me, it is about 13% of my deferred accounts. Doesn't seem to makes a lot of sense to take after tax money and have it's basis figured into a tax situation.

You might want to look into the possibility of opening a self employed 401K plan at a brokerage that accepts transfers into it. (Vanguard does not).
Then you transfer in all your IRA's except the one that has nondeductible contributions in it.

Then you roll over that one IRA, to a Roth, calculating the taxable/nontaxable portions to get the amount of tax due from the rollover.

Then you can always keep or close your 401K after rolling it back to an IRA.