Post-tax IRA, 30 years later

[Mr._Graybeard]

When DW and I got married, I got to assess her opportunities for retirement savings and found her company plan to be very poor. As a result I convinced her to open a personal IRA and deposit $2000 a year. Since she already had a company plan, the IRA deposit was not tax deductible, or at least that was my understanding of the IRA law at the time. So, after 10 years she had a $23K IRA after interest and earnings. At that time the company improved its retirement plan dramatically, and we started using that plan for payroll deductions.

Fast-forward 20 more years, and the IRA account has $175k in it. There were no Roths at the time we opened it, but I'm thinking this account should work like a Roth. We paid taxes on the income before depositing it into the account.

I know we have some tax and accounting experts on the board. Experts, is my thinking straight?

 

[audreyh1]

You will owe taxes on the amount above the initial deposits.

Is her company plan a 401K? If so you might want to convert the IRA to a Roth if that’s her only one.

 

[L-5Player]

If every contribution made to the IRA was non-deductible, then the total of those contributions is your post-tax basis. Let's say it's $20,000.

This post-tax basis is a percentage of the total balance. If the balance is $175,000 then the post-tax percentage is 20/175 = 11.43%. When you make a withdrawal, 11.43% of the withdrawal will be tax-exempt. The remaining 88.57% will be taxable as regular income.

This is called pro rata, or pro-rating, and it's a major difference for how traditional IRA withdrawals are taxed vs. Roth IRAs, which have no taxation at all if you follow the IRS rules.

 

[Mr._Graybeard]

You will owe taxes on the amount above the initial deposit.

Is her company plan a 401K? If so you might want to convert the IRA to a Roth if that’s her only one.

The company plan was a 401k, but we rolled that account into an IRA at Vanguard.

DW turns 70 1/2 in a month. I think we'll use the IRA in question to make charitable contributions now that I understand the tax implications (thanks, folks). It has always been something for a sideshow for us, so it wouldn't hurt to just give it away.

 

[Dash man]

Good decision!

 

[oldtimer]

The company plan was a 401k, but we rolled that account into an IRA at Vanguard.

DW turns 70 1/2 in a month. I think we'll use the IRA in question to make charitable contributions now that I understand the tax implications (thanks, folks). It has always been something for a sideshow for us, so it wouldn't hurt to just give it away.

If your DW has 2 or more IRA's (not Roth IRAs) then the IRS considers all of them in total as a single traditions IRA. When doing your taxes the non-deductible contributions will be pro-rata across all the non-Roth IRAs balance totals. It does not matter which traditional IRA you take a withdrawal. Though a QCD is the one exception that is not done pro-rata, but 100% pretax money. Gotta love the these tax laws!

 

[RE2Boys]

When DW and I got married, I got to assess her opportunities for retirement savings and found her company plan to be very poor. As a result I convinced her to open a personal IRA and deposit $2000 a year. Since she already had a company plan, the IRA deposit was not tax deductible, or at least that was my understanding of the IRA law at the time. So, after 10 years she had a $23K IRA after interest and earnings. At that time the company improved its retirement plan dramatically, and we started using that plan for payroll deductions.

Fast-forward 20 more years, and the IRA account has $175k in it. There were no Roths at the time we opened it, but I'm thinking this account should work like a Roth. We paid taxes on the income before depositing it into the account.

I know we have some tax and accounting experts on the board. Experts, is my thinking straight?

Each year you made a non-deductible contribution to your TIRA you were required to report these contributions and basis in your IRA as part of your income tax return using Form 8606. The form will guide you in calculating the taxable part of each distribution. Your basis, as reported to the IRS, will be found in the very last 8606 that you filed. I hope you have been filing this form each year you made non-deductible contributions and each year you took any distributions. You would have needed to file separate 8606 if both you and your wife made non-deductible contributions.

 

[audreyh1]

The company plan was a 401k, but we rolled that account into an IRA at Vanguard.

DW turns 70 1/2 in a month. I think we'll use the IRA in question to make charitable contributions now that I understand the tax implications (thanks, folks). It has always been something for a sideshow for us, so it wouldn't hurt to just give it away.

Well since you already rolled the 401K into an IRA you’re stuck with proportional post-tax basis across all her IRAs, not just the one.

If your DW has 2 or more IRA's (not Roth IRAs) then the IRS considers all of them in total as a single traditions IRA. When doing your taxes the non-deductible contributions will be pro-rata across all the non-Roth IRAs balance totals. It does not matter which traditional IRA you take a withdrawal. Though a QCD is the one exception that is not done pro-rata, but 100% pretax money. Gotta love the these tax laws!

Well thank goodness for that!

Each year you made a non-deductible contribution to your TIRA you were required to report these contributions and basis in your IRA as part of your income tax return using Form 8606. The form will guide you in calculating the taxable part of each distribution. Your basis, as reported to the IRS, will be found in the very last 8606 that you filed. I hope you have been filing this form each year you made non-deductible contributions and each year you took any distributions. You would have needed to file separate 8606 if both you and your wife made non-deductible contributions.

Oh yeah, good old form 8606. TurboTax has been tracking that for me all these years. I’ve even kept paper copies of the original ones.

One of my IRAs is all post-tax contributions basis. I’ll be dealing with that basis when I start taking RMDs.

 

[mystang52]

Maybe I misunderstood some of the replies here. I'm in a similar situation. I have a small post-tax IRA. My understanding was that when I start withdrawing, my post tax contributions are divided by MY ENTIRE IRA holdings, to determine the tax exempt amount. I find this unfair, but that's what I was told, on this site, many years ago.

 

[L-5Player]

My understanding was that when I start withdrawing, my post tax contributions are divided by MY ENTIRE IRA holdings, to determine the tax exempt amount.

That's correct. Every withdrawal's tax-exempt portion is prorated using the proportion of post-tax dollars in the full balance.

So if you have $1M in your IRA with $100k in total non-deductible contributions, then you will be taxed on 90% of your withdrawal.

The balance used to calculate this is as of COB on 12/31 during the year in which the withdrawal is taken. It's typically found on the final December statement published by your broker, made available in January.

 

[Mr._Graybeard]

Thanks for all the replies, folks. I can't recall about Form 8606 -- our last post-tax contribution was 20 years ago, and we had a CPA do our taxes back then. Factoring in DW's other IRA, the post-tax contribution is negligible anyway. I'm glad I know now where we stand without having to wade through a couple pages of IRS prose.

 

[MarieIG]

I also had a non-deductible IRA wherein all the growth was taxable, however the CPA had been filing the 8606. Nevertheless the growth by far surpassed the contributions. With assistance on this forum, (in particular PB4uski) I (held my nose due to the stinkiness of the company 401k), rolled the growth into the 401k for a period of time, and converted the contribution portion. I did not have much time after that, but the following year did a quick non-deductible IRA and Roth conversion, front loaded my Roth 401k and rolled my Roth 401k out into my Roth IRA.

I think your plan is great, and intend to use my traditional IRA for QCDs when I qualify.

 

[audreyh1]

Maybe I misunderstood some of the replies here. I'm in a similar situation. I have a small post-tax IRA. My understanding was that when I start withdrawing, my post tax contributions are divided by MY ENTIRE IRA holdings, to determine the tax exempt amount. I find this unfair, but that's what I was told, on this site, many years ago.

That is correct.