Traditional IRA Advice

[windowsi11]

Hello community, 

I have a question regarding a traditional IRA account that I own, and the tax implications of investing and moving money within or out of it. 

The IRA’s ‘seed money’ of $1,000 was invested by my parents as a gift to me a long time ago.  He invested it with a wealth management company who put it into a mutual fund where it stayed untouched for years. The dividends, as far as I can tell, were not reinvested, but placed into an insured cash account. 

I didn’t know anything about investing and more or less forgot about the account. The only contribution I ever made was a deposit of $1000 from my savings. The wealth management company put this into the insured cash account.  I deducted it on my taxes at the time, but now I think I made a mistake because that was after-tax money.  I didn’t file the 8606 or any other IRS form to report a non-deductible contribution. 

I very recently transferred this IRA account to another custodian and sold the existing mutual fund.  I would now like to reinvest that money, ideally by either (1) pooling the money from the old insured cash account and mutual fund sale and buying a new mutual fund, or (2) rolling the money over into my Roth IRA. However, after doing some reading I’m confused about the tax implications of what I think was a mistake with my deposit, and I’m unsure about the best course of action.  Any advice you can give would be much appreciated.

[Critter-3]

OK ... the EARNINGS  were NOT contributions and should NOT have been deducted or reported on your tax return.  Of course the dividends on such a small amount could not have been much especially since they were not reinvested.   So if you reported them as taxable dividends when you shouldn't have (since no tax reporting form was issued)  then all you can do is amend the open tax years (2019 - 2021)  if this even makes a difference worth the effort.

Now when you do take a distribution from the IRA it is fully taxable. 

However if you ROLL the IRA into a different IRA you can invest it any way you wish. Sales and purchases INSIDE an  IRA  are  not taxable events and are never reported on an income tax return.

OR you can CONVERT   the traditional IRA into a ROTH which is a taxable event ... all the converted funds are taxable on your return.

[windowsi11]

Thank you for your response, Critter-3.  I did not report any tIRA earnings or dividends on my tax returns, but I do think I had a fundamental misunderstanding, so let me try and rephrase my question.  

I goofed when making that $1000 deposit to my IRA.  I deducted it when I shouldn't have.  However, by deducting it, I have functionally made it a pre-tax contribution (even though it shouldn't have been).   So I set myself up for double-taxation on that money. 

When I wrote my initial question, I was concerned about co-mingling pre-tax and after-tax money in my tIRA, because of the more complicated accounting for distributions that occurs when that happens.  However, I shouldn't be, because my deduction made my contribution pre-tax.  So it's just all pre-tax money in there (assuming my parents' gift was pre-tax to begin with).  

Please correct me if I'm wrong.  

[SteamTrain]

@windowsi11 

From what you've said so far, it sounds like your additional $1000 contribution was entered on that year's tax return as a deductible IRA  contribution in for that year.   Thus, yes, it became effectively pre-tax $$.

All earnings in that account are thus, pre-tax too  ( "assuming my parents' gift was pre-tax to begin with"    Yeah, I'm not conversant on rules for parents creating/gifting an IRA for a child, maybe @dmertz  could comment on that if he is monitoring TTX right now).

_________________________

Whether it was a goof to make that extra $1000 a deductible contribution would be a tossup.  Sometimes non-deductible contributions can cause massive calculation confusions when distributions or conversions are eventually made.....but since it appears that all the account is considered pre-tax $$, it is far simpler to deal with when either transferring to another t-IRA, or converting to a ROTH IRA.

______________

double taxation though???  Nahhh  (just my Opinion).   Because it was a deductible contribution, those $$ were removed from your AGI in the year you made the contribution...it became non-taxed money....so it gets taxed just once when distributed, or converted to a ROTH IRA.  I guess it's possible for folks who had low income in the year of the contribution, where their income was so low that they had no tax liability in the first place and the contribution really didn't help them, but then....they might have received a Retirement Savings Contribution Credit that year to make up for that.

[Critter-3]

Agree ... you have a traditional IRA and you have done nothing wrong and there is nothing you can do to change it at this late date.  Since you are young you can convert the entire IRA to a ROTH  and enjoy tax free growth and distribution later  as opposed to paying taxes on all of the contribution and earnings later.   Of course we are only talking about a couple of thousand $$ right now  so depending on your income level making the conversion will not be as painful as it could be later in life  when your income tax rate is higher. 

[SteamTrain]

I guess the main thing I'm concerned & confused about, is how the original parent's $1000 IRA seed is treated.

....or how it was supposed to be treated at the time that original seed-IRA was created.  

Like, did you have other earned (job) income in the year the original seed-IRA was created....and how was that contribution reported that year?  

OR maybe I'm just complicating the situation more than needed.   

[windowsi11]

Thank you both for your responses. Obviously I'm new at considering these matters, so it's breaking my brain a little.

I guess I got mistakenly hung up on the idea that the contribution from my savings equates to an after-tax contribution. What matters, if I understand correctly, is that I deducted the contribution that year, thus deferring $1000 worth of my taxable income, and in effect making my contribution a pre-tax one. So no double taxation. 

SteamTrain, thank you for alerting me to potential issues with the seed money. I did have my own earned income that year, but I've no clue how they reported that contribution. I'll have to do what I can to find out.

[fanfare]

"the idea that the contribution from my savings equates to an after-tax contribution. "

 This is an election you can make. To make it non-deductible (or if it is forced to be non-deductible) file Form 8606.

 the usual reason for the election is for Roth IRA purposes.

@windowsi11 

[dmertz]

By taking a deduction for the traditional IRA contribution, the money became pre-tax money in your traditional IRAs.  Earnings are also pre-tax, so you have no after-tax money in your traditional IRAs, more properly stated as having no basis in nondeductible traditional IRA contributions.  Any distribution from your traditional IRAs that is not rolled over, or a Roth conversion, is fully taxable.