Good info on non-deductible contributions to IRA and the 8606?

[still_working]

As a complement to our workplace retirement plans we'd like to start contributing post-tax dollars to an IRA. Income limits prevent us from deducting and also prevent us from contributing to a Roth, and pro rata issues will prevent us from using a back door Roth as the instrument for this.


Tracking post-tax non-deductible contributions for the life of the tIRA for the purpose of not being taxed on the principal at WD seems.....tedious. Apparently the 8606 is used for this purpose, but I'd like to learn more before we start down this path.


If you have any good links or tips on the mechanics of contributing and tracking across a decade or more, I'd appreciate them.

 

[SecondCor521]

Yes, Form 8606 is used for tracking basis in traditional IRAs. Specifically, Part I of Form 8606.

Form 8606 can be filed with your tax return annually, or separately. It's easier if you file it with your tax return and do it right from the beginning.

There is a penalty if you're supposed to file a Form 8606 but do not; however it is generally said that the IRS doesn't enforce this penalty.

I think the instructions for Form 8606 are confusing, but the idea is that you'll record your nondeductible contributions each year on Form 8606, and the basis gets carried forward from year to year, accumulating as you go.

You'll need to have a separate series of 8606s for each spouse if or when you both do non-deductible contributions.

When you go to withdraw from your IRAs (or do Roth conversions), whatever fraction of your IRA that is basis is not taxed (provided you keep track of the basis appropriately). The fraction is somewhere around the middle of Part I. Roth conversions are handled on Part II of Form 8606.

Since the basis is carried forward on the 8606 from year to year, if you're doing things correctly you only need to retain the most recently filed 8606(s).

Depending on your investing style, you may find that contributing to a regular taxable brokerage account may work out better. You will lose out on tax deferral, but you'll be taxed at capital gains rate rather than ordinary income tax rates. Also, taxable brokerage accounts are useful for spending money in your 50s and/or paying taxes on Roth conversions - which is what I'm doing.

 

[gauss]

I was fortunate that when I was working, my employer's 401K would accept incoming rollovers from a traditional IRA. I was able to isolate my basis and then Roth converts the after-tax component. After that I would contribute after tax to the IRA and then Roth convert shortly thereafter. Not having the pre-tax money in there anymore made the pro rata rules much less of an issue.

Gauss

 

[Montecfo]

i recommend you set up a separate IRA to hold only nondeductible contributions.

Makes recordkeeping more straightforward.

 

[cathy63]

I keep a spreadsheet with these columns:
Year
After Tax Contribution
Pre-tax 401(k) Rollover
Excess Contrib Withdrawn
Roth Conversion Amount
EOY Account Value
EOY Basis
Notes

I have a tab for each IRA, Roth and HSA. Columns are similar for each tab, except the 401k rollover and excess contribs only apply to the tIRAs. I update it every year before doing the taxes. TurboTax keeps track of the basis for me and uses it to fill out our 8606s as necessary (you don't file one every year, only when you have activity in your account), so I just verify that the number I have for the basis matches what ends up on whichever 8606s are filed. When I print out the tax return, I also print a copy of the spreadsheet and file them together. It currently has 23 rows, so it's been working pretty well for a long time.

 

[cathy63]

i recommend you set up a separate IRA to hold only nondeductible contributions.

Makes recordkeeping more straightforward.

How so? The earnings in the account that receives your after-tax contributions will be taxable, so you'll always have comingled money in that account anyway.

 

[swakyaby]

I would recommend not starting a nondeductible IRA. I was in the same situation as you—I had maxed out my tax-deferred retirement plan, was in a high tax bracket and did not qualify for a Roth IRA or a tax-deferred IRA. But by contributing to a non-deductible IRA, you must now track your cost basis across all your IRAs. And when you withdraw, the gains are taxed at ordinary income rates. Whereas, if you instead invest it in taxable investments, the gains are taxed at the more favorable long term capital gains rate.

I do wish I had never started a non-deductible IRA and had instead put the extra income into tax efficient mutual funds.

 

[still_working]

Thanks to all - great, thoughtful perspectives and really underscores why I wanted to post the question here versus elsewhere.


The discussion (and further reflection) has me wondering why I'd go through all that effort to track non-taxable contributions to a retirement account rather than just building the taxable brokerage account. On the surface, it seems there could be a very slight tax difference - IRA would be tax on growth as earnings, versus brokerage account would be capital gains on growth.


Genuinely appreciate the discussion here - I haven't been an active poster but have appreciated all the great dialog and discussion in the forum for as long as I've been a member, for many of the reasons exposed in this thread. Thanks, all.

 

[beowulf]

Once you close out a nondeductible IRA (withdraw all the money) that you filed an 8606 for every year, is there any requirement to continue filing that form? The basis amount is very small and provides an inconsequential amount of tax savings. It's just another form that I see no point in preparing every year.

 

[SecondCor521]

Once you close out a nondeductible IRA (withdraw all the money) that you filed an 8606 for every year, is there any requirement to continue filing that form? The basis amount is very small and provides an inconsequential amount of tax savings. It's just another form that I see no point in preparing every year.

No. If the tax savings aren't worth it to you then you can stop and just treat it all of the withdrawals or conversions as taxable.

 

[Alan]

Once you close out a nondeductible IRA (withdraw all the money) that you filed an 8606 for every year, is there any requirement to continue filing that form? The basis amount is very small and provides an inconsequential amount of tax savings. It's just another form that I see no point in preparing every year.

Once you have no basis in your IRAs you stop filing the 8606.

Since the OP currently has no deductible IRAs he could make a contribution and immediately do a Roth conversion. He would file an 8606 each year he makes the contributions and conversions but when he comes to withdrawals, no 8606s required since all the money including growth in the Roth is tax free.

 

[SecondCor521]

Once you have no basis in your IRAs you stop filing the 8606.

Since the OP currently has no deductible IRAs he could make a contribution and immediately do a Roth conversion. He would file an 8606 each year he makes the contributions and conversions but when he comes to withdrawals, no 8606s required since all the money including growth in the Roth is tax free.

Huh. I read the phrase "pro rata issues will prevent us" in the OP to indicate that OP *did* have deductible IRAs. Perhaps OP could clarify that point.

 

[beowulf]

Thank you for your response. Alan. I hadn't considered Roth conversions as we do have separate Roth accounts. And. due to our age, pensions, SS and RMDs, Roth conversions don't make a lot of sense for us tax wise.

When you say no basis, do you mean that a closed out nondeductible IRA has no basis as it no longer exists? That makes sense and we plan to close out my wife's nondeductible IRA this year. If we do so, I guess that our return for 2022 would be the last year we file an 8606?

Thanks again for your help.

 

[beowulf]

Huh. I read the phrase "pro rata issues will prevent us" in the OP to indicate that OP *did* have deductible IRAs. Perhaps OP could clarify that point.

At one time we had two nondeductible IRAs. One was closed out a few years ago. The other is still there, however, we plan to close it this year. We have been filing 8606's for both accounts since their inception over 25 years ago, to include the closed one. The IRS rules are very hard to understand as to whether or not the 8606 still has to be filed once you close the account. There was basis left when we closed the first one and the rules seem to indicate that you continue to file the form until all basis is gone (which seems to be impossible to achieve - the number keeps dropping every year, but will take forever to reach 0).

Any advice is appreciated.

 

[still_working]

Huh. I read the phrase "pro rata issues will prevent us" in the OP to indicate that OP *did* have deductible IRAs. Perhaps OP could clarify that point.

SecondCor has it correct; we have existing tIRAs in addition to our employer's retirement plans so any backdoor Roth conversions would be subject to pro rata. I was hoping to do this until I learned of the pro rata rule, but alas.

 

[Montecfo]

How so? The earnings in the account that receives your after-tax contributions will be taxable, so you'll always have comingled money in that account anyway.

Sure but you are confining it to a smaller bucket. Do not have to wonder whether a contribution to it was deducted or not.

And if you want to roll your deductible IRA back into another plan, you have not complicated your life by commingling funds.

Also, say you want to "fix" your backdoor Roth issue by rolling your deductible IRA into your 401k. If you commingled contributions, this fix does not work in many cases.

 

[Alan]

Huh. I read the phrase "pro rata issues will prevent us" in the OP to indicate that OP *did* have deductible IRAs. Perhaps OP could clarify that point.

I missed that, thanks for the correction.

Thank you for your response. Alan. I hadn't considered Roth conversions as we do have separate Roth accounts. And. due to our age, pensions, SS and RMDs, Roth conversions don't make a lot of sense for us tax wise.

When you say no basis, do you mean that a closed out nondeductible IRA has no basis as it no longer exists? That makes sense and we plan to close out my wife's nondeductible IRA this year. If we do so, I guess that our return for 2022 would be the last year we file an 8606?

Thanks again for your help.

When you say a “closed out nondeductible IRA that no longer exists” do you mean that there is nothing in it? I assume so which means there is no basis in that IRA as all contributions have been withdrawn.

For the purposes of basis when calculating Roth conversions then 401ks are excluded which is why I left my 401k in my employer’s plan for a year after retirement while I converted my deductible IRA which had a lot of basis i.e. after-tax contributions. The only tax paid was on the gains of the IRA, the money in the 401k was not part of the pro-rata calculation.

If you no longer have any IRAs other than Roth IRAs then you can make a contribution to a nondeductible IRA and immediately convert it to a Roth with virtually no tax depending on how much it has grown in the few days it took to convert.

 

[cathy63]

...When you say no basis, do you mean that a closed out nondeductible IRA has no basis as it no longer exists? That makes sense and we plan to close out my wife's nondeductible IRA this year. If we do so, I guess that our return for 2022 would be the last year we file an 8606?

I can't tell if your wife currently has other traditional IRA accounts besides the one with the basis. If she does, then closing out the one account is irrelevant. To the IRS, she only has one giant tIRA and the basis is just a portion of the total value.

 

[swakyaby]

I can't tell if your wife currently has other traditional IRA accounts besides the one with the basis. If she does, then closing out the one account is irrelevant. To the IRS, she only has one giant tIRA and the basis is just a portion of the total value.

My CPA confirms this too.

 

[swakyaby]

When you have a nondeductible IRA, the pro rata rules apply not only to Roth IRA conversions, but also apply to IRA withdrawals from any IRA account. The IRS treats all your individual IRAs as one big IRA pie. You’ll never be able to stop tracking your cost basis until every IRA goes to a balance of zero.

 

[beowulf]

I guess I’m missing something. All our IRAs, my wife’s and mine, are deductible with the exception on one Roth for each of us. When we take RMDs or make withdrawals, they are taxed as regular income. There is no basis for those. Once both non deductible IRAs are closed, as one is already, what’s the point of filing the 8606 forever when the amount of tax reduction is very small. If we don’t care about it, why would the IRS? It reduces our taxes, it doesn’t give money to the government.

 

[SecondCor521]

I guess I’m missing something. All our IRAs, my wife’s and mine, are deductible with the exception on one Roth for each of us. When we take RMDs or make withdrawals, they are taxed as regular income. There is no basis for those. Once both non deductible IRAs are closed, as one is already, what’s the point of filing the 8606 forever when the amount of tax reduction is very small. If we don’t care about it, why would the IRS? It reduces our taxes, it doesn’t give money to the government.

I thought I already answered this question in post #10 on this thread.

It's hard to tell though - you might still not be understanding what others are saying about the IRS treating all of your IRAs as one large pie for the purposes of applying the pro rata rule.

You might think that if you have a deductible IRA and a nondeductible IRA and make a distribution(*) from the nondeductible IRA, that doing so means that you can avoid the pro rata rule. You cannot. The IRS will treat the distribution as being made on a pro rata basis from both IRAs even though the distribution itself came from only one IRA account.

If you've been taking the distribution from the nondeductible IRA while you also have deductible IRA balances and think you've been reducing (or filing taxes as though you are reducing) your basis dollar for dollar, then you've been doing your taxes incorrectly (and could have a tax mess on your hands).

(*) including Roth conversions and RMDs.

 

[SecondCor521]

At one time we had two nondeductible IRAs. One was closed out a few years ago. The other is still there, however, we plan to close it this year. We have been filing 8606's for both accounts since their inception over 25 years ago, to include the closed one. The IRS rules are very hard to understand as to whether or not the 8606 still has to be filed once you close the account. There was basis left when we closed the first one and the rules seem to indicate that you continue to file the form until all basis is gone (which seems to be impossible to achieve - the number keeps dropping every year, but will take forever to reach 0).

Any advice is appreciated.

If a taxpayer is following the pro rata rules properly and drains all of their traditional IRA accounts to zero, then in that final year, it is possible that the account value is higher than the remaining basis. In that scenario my understanding is that draining the accounts to zero uses up as much basis as possible and any remaining basis would represent a loss that might be able to be taken as an itemized deduction in that final year.(1) This is a pretty rare scenario but could happen if the value of the IRA(s) drop in that final year.

The only way for the basis to go down is if distributions(2) are being made. I don't know how you can be making distributions if the accounts are all closed. So what you're saying there is a bit confusing to me.

Are you doing your 8606s on a taxpayer basis? You should be filing one 8606 with your tax return if there is any applicable activity in any of your IRAs, and you should be filing a second 8606 with your tax return if there is any applicable activity in any of your spouse's IRAs. You should not be filing 8606s on an account-by-account basis, so even if you had two (or more) IRA accounts of your own with applicable activity, you would aggregate that activity on your 8606.

But if *all* IRAs (traditional deductible, traditional non-deductible, rollover, SIMPLE, and SEP (3)) for a given taxpayer are closed, and the taxpayer doesn't make any transactions in any of those accounts that would require one to be filed, then the taxpayer would not be required to file a Form 8606 in that year.

...

By the way, this has been a little confusing to see you respond to my request to the OP for clarification with your own answer. Unless you have two different logins or are married to the OP or something (?), then you are not the OP (OP = original poster = still_working). But I doubt that's the case since the OP seems to be unfamiliar with 8606s and you seem to be very familiar with them.

----------------------------------

(1) Or at least it used to. I think it was a miscellaneous itemized deduction that was suspended by the TCJA, but I'd have to go look to be sure.

(2) Again, either RMDs, or Roth conversions. And QCDs as well, I suppose.

(3) But excluding inherited IRAs, which are technically not the taxpayer's IRA anyways.

 

[cathy63]

I guess I’m missing something. All our IRAs, my wife’s and mine, are deductible with the exception on one Roth for each of us. When we take RMDs or make withdrawals, they are taxed as regular income. There is no basis for those. Once both non deductible IRAs are closed, as one is already, what’s the point of filing the 8606 forever when the amount of tax reduction is very small. If we don’t care about it, why would the IRS? It reduces our taxes, it doesn’t give money to the government.

The part that's confusing for some of us is that you are talking about "deductible", "non-deductible" and "Roth" IRAs and the closing of "non-deductible" accounts. It's hard to untangle what you mean by a "non-deductible IRA" because that's not a standard term.

You and your spouse each have two buckets of money. One is your "traditional IRA" (tIRA) bucket. The other is your "Roth IRA" bucket. Each bucket can have multiple accounts in it, but the IRS will always treat each bucket as if it were one big account, so between you, there are four separate buckets to keep track of.

If either of you puts money into any account in their tIRA bucket and does not deduct it as an IRA contribution, then that person has a basis in their tIRA until the year in which they close all their tIRA accounts and have no tIRA money left. That person has to file an 8606 during any year in which they add more non-deductible money or take any money out (including by converting it to a Roth IRA). They don't have to file an 8606 in a year where the traditional IRA with a basis is just sitting there growing untouched.

My confusion arose when you said that you had closed your non-deductible account but you still had a basis that you now want to ignore. It's not really possible to have a basis in a tIRA if you don't have a tIRA any more (unless you're in the extremely rare situation SecondCor521 described), so I was trying to figure out if maybe you had been reporting this incorrectly on your taxes in past years and as a result you might have underpaid the IRS.

If you're sure that your past tax returns are correct, you can ignore the basis going forward. You'll just be double-taxed on some of the money, but that's your choice to make. You do still have to file an 8606 if you do any Roth conversions, but you would just enter the basis in the tIRA as $0.

 

[fh2000]

I thought I already answered this question in post #10 on this thread.

It's hard to tell though - you might still not be understanding what others are saying about the IRS treating all of your IRAs as one large pie for the purposes of applying the pro rata rule.

You might think that if you have a deductible IRA and a nondeductible IRA and make a distribution(*) from the nondeductible IRA, that doing so means that you can avoid the pro rata rule. You cannot. The IRS will treat the distribution as being made on a pro rata basis from both IRAs even though the distribution itself came from only one IRA account.

If you've been taking the distribution from the nondeductible IRA while you also have deductible IRA balances and think you've been reducing (or filing taxes as though you are reducing) your basis dollar for dollar, then you've been doing your taxes incorrectly (and could have a tax mess on your hands).

(*) including Roth conversions and RMDs.

To avoid pro rata rule, we first rolled other TIRAs to our 401K accounts, then we Roth converted all NonDeductible IRAs in full. To record our cost bases, I had to manually input that in TurboTax Form 8606. Otherwise, their question/answer interface does not trigger that figure.