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nblandfo
Returning Member

Non-deductible contributions to Traditional IRA. 8606 or not?

I have a traditional IRA from a previous employer. I now make non-deductible contributions each year which I track. From my understanding, reporting these contributions on Form 8606 prevents double-tax on withdrawal in the future. However, you get a tax break (IRA deduction line 19) if you make these contributions deductible. So which is more beneficial? Yeah, you avoid a double tax but you get a tax break now. 

I am just discovering form 8606, and have failed to file it 2018-2020. I already got the tax break for the deductible contributions I made for these years. If I decide to change this as non-deductible contributions via Form 8606 (as they were actually post-tax when I contributed), do I need to amend each year's tax return since I was overpaid (IRA deduction line 19)?

Thanks

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Non-deductible contributions to Traditional IRA. 8606 or not?


@nblandfo wrote:

Thanks for the reply.

This is a rollover IRA which I initially funded from account with my previous employer to consolidate. 


Ok, so let's talk some basic concepts.

 

If you make deductible contributions to an IRA, you get a deduction now and you pay tax later.

If you make a Roth IRA contribution now, you don't get a tax deduction now and you don't pay tax later.

 

These two strategies kind of wash out, if you contribute properly.  For example, you can contribute $100 to a traditional IRA or $70 to a Roth IRA, and have the same amount of money left over after taxes.  That $70 will grow less over time, but you pay no tax when withdrawing; the IRS grows more but you pay tax when you withdraw.

 

Making non-deductible contributions to a traditional IRA, instead of making non-deductible contributions to a Roth IRA, makes a mess of everything.  It means you now have a partial basis in your IRA, and your withdrawals will be partially non-taxable.  (For example, if 10% of IRA contributions are non-deductible, then 10% of future withdrawals are non-taxable.)  But it rarely makes sense to make non-deductible contributions to a traditional IRA when you could have contributed to a Roth IRA, if you really want to make non-deductible contributions.

 

(There are some potential advantages to having Roth IRA money, or a mix of traditional and Roth IRA money, when you retire.  Too complicated to get into now.  But if you want non-taxable retirement money, you really should be contributing to a Roth IRA and not making non-deductible contributions to a traditional IRA.)

 

But, we're stuck with what we have so far.

 

For the present situation:

For 2018, if you made non-deductible contributions, it is too late to file an amended return to change them to deductible and get a refund.  You will need to file form 8606 to list and track your non-deductible contributions.

 

For 2019 and 2020, it would be better long-term to make all your contributions deductible.  I believe you can do this by an amended return since the contributions were made on time, you are just changing the treatment of the contribution.  (I can't find an instruction to confirm this would be allowed or not allowed.)  If you must leave the contributions as non-deductible, then you must file an amended return to file form 8606 for each year, to report and track your non-deductible contributions.   You must prepare the returns in chronological order, because your 2019 form 8606 will require information from the 2018 form, and so on.

 

For the Future:

If you want to make non-deductible contributions, so you can withdraw money in the future tax-free, open a Roth IRA instead.

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14 Replies

Non-deductible contributions to Traditional IRA. 8606 or not?

We need to start with a clarification.

An "employer" plan is not an IRA. Qualified employer plans might be a 401(k), a 403(b), a 401(a), a 457 plan, or something else.  (The number refers to the section of the tax code that authorizes the plan.)  An IRA is an individual account you set up with a bank or broker.  Even though they have similar purposes to qualified workplace plans, they are covered by different sections of the tax law, and have some rules that are very different.

 

In particular, you generally can't contribute to a workplace plan once you leave the employment of the sponsor. You can contribute to a different account with the same trustee, but it is a different account.  For example, if you have a 401(k) at Fidelity, and you leave that employer, you can probably open a traditional IRA at Fidelity, but that will be a private account separate from the 401(k) account, and you can't contribute directly to the 401(k) account.  

 

Then, if you contribute to an IRA (no matter who the trustee is) you can make deductible or non-deductible contributions.  Your ability to make deductible contributions may be limited based on your income and employment situation.  You can also have a Roth IRA if you prefer, but that must be set up differently.

 

So now, before we can really help you, we need to know more details about what you are actually doing.  

Non-deductible contributions to Traditional IRA. 8606 or not?


@nblandfo wrote:

I have a traditional IRA from a previous employer. I now make non-deductible contributions each year which I track. From my understanding, reporting these contributions on Form 8606 prevents double-tax on withdrawal in the future. However, you get a tax break (IRA deduction line 19) if you make these contributions deductible. So which is more beneficial? Yeah, you avoid a double tax but you get a tax break now. 

I am just discovering form 8606, and have failed to file it 2018-2020. I already got the tax break for the deductible contributions I made for these years. If I decide to change this as non-deductible contributions via Form 8606 (as they were actually post-tax when I contributed), do I need to amend each year's tax return since I was overpaid (IRA deduction line 19)?

Thanks


Assuming that you rolled the previous employer plan into a Traditional IRA then...

 

There is really no reason to make a nondeductible contribution to a Traditional IRA when you are qualified to deduct it.   About the only reason to make a nondeductible contribution is when you are covered by a retirement plan at work and you income AGI is too high to be able to deduct or to contribute to a Roth IRA (which are always after-tax contributions.    If your AGI permits, you can just contribute to a Roth IRA instead if you want tax free distributions in the future.

 

And...

You can NEVER withdraw ONLY the nondeductible part - it must be prorated over the entire value of ALL Traditional IRA accounts which include SEP and SIMPLE IRA's. (For tax purposes you only have ONE Traditional IRA which can be split between as many different accounts as you want, but for tax purposes they are all added together).

For example using rough figures: if you had $60K of nondeductible contributions in an IRA with a total value of $600K (10:1 ratio), then when you take a $60K distribution from any IRA account $6,000 would be nontaxable and $54,000 would be taxable (same 10:1 ratio) , with the remaining $54K of basis staying in the IRA for future distributions. As long as there is any money in the IRA, there will be some basis.

TurboTax will ask for your non-deductible "basis" and then the *Total Value* of *all* Traditional IRA, SEP and SIMPLE accounts as of Dec 31, of the tax year. That is so the prorating of the basis can be properly proportioned between the current years distribution and the remaining IRA value. That is done on the 8606 form.

 

 

 

 

 

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**
nblandfo
Returning Member

Non-deductible contributions to Traditional IRA. 8606 or not?

Thanks for the reply.

This is a rollover IRA which I initially funded from account with my previous employer to consolidate. 

nblandfo
Returning Member

Non-deductible contributions to Traditional IRA. 8606 or not?

Thanks for the reply.

So If I do not file a form 8606 and make these contributions deductible (how I've filed 2018-2020), won't I be double taxed once I withdraw since I am making these contributions post-tax? Or is that where the tax-break applies (IRA deduction, form 1040 line 19 under Adjustments to Income)?

I do not have an employer retirement plan currently. Every contribution I make, I have been making from my net paycheck

Non-deductible contributions to Traditional IRA. 8606 or not?


@nblandfo wrote:

Thanks for the reply.

This is a rollover IRA which I initially funded from account with my previous employer to consolidate. 


Ok, so let's talk some basic concepts.

 

If you make deductible contributions to an IRA, you get a deduction now and you pay tax later.

If you make a Roth IRA contribution now, you don't get a tax deduction now and you don't pay tax later.

 

These two strategies kind of wash out, if you contribute properly.  For example, you can contribute $100 to a traditional IRA or $70 to a Roth IRA, and have the same amount of money left over after taxes.  That $70 will grow less over time, but you pay no tax when withdrawing; the IRS grows more but you pay tax when you withdraw.

 

Making non-deductible contributions to a traditional IRA, instead of making non-deductible contributions to a Roth IRA, makes a mess of everything.  It means you now have a partial basis in your IRA, and your withdrawals will be partially non-taxable.  (For example, if 10% of IRA contributions are non-deductible, then 10% of future withdrawals are non-taxable.)  But it rarely makes sense to make non-deductible contributions to a traditional IRA when you could have contributed to a Roth IRA, if you really want to make non-deductible contributions.

 

(There are some potential advantages to having Roth IRA money, or a mix of traditional and Roth IRA money, when you retire.  Too complicated to get into now.  But if you want non-taxable retirement money, you really should be contributing to a Roth IRA and not making non-deductible contributions to a traditional IRA.)

 

But, we're stuck with what we have so far.

 

For the present situation:

For 2018, if you made non-deductible contributions, it is too late to file an amended return to change them to deductible and get a refund.  You will need to file form 8606 to list and track your non-deductible contributions.

 

For 2019 and 2020, it would be better long-term to make all your contributions deductible.  I believe you can do this by an amended return since the contributions were made on time, you are just changing the treatment of the contribution.  (I can't find an instruction to confirm this would be allowed or not allowed.)  If you must leave the contributions as non-deductible, then you must file an amended return to file form 8606 for each year, to report and track your non-deductible contributions.   You must prepare the returns in chronological order, because your 2019 form 8606 will require information from the 2018 form, and so on.

 

For the Future:

If you want to make non-deductible contributions, so you can withdraw money in the future tax-free, open a Roth IRA instead.

Non-deductible contributions to Traditional IRA. 8606 or not?


@nblandfo wrote:

Thanks for the reply.

So If I do not file a form 8606 and make these contributions deductible (how I've filed 2018-2020), won't I be double taxed once I withdraw since I am making these contributions post-tax? Or is that where the tax-break applies (IRA deduction, form 1040 line 19 under Adjustments to Income)?



Correct.  If you do not report and track your non-deductible contributions on form 8606, then all your withdrawals will be taxed, which results in double-taxation because a portion of your contributions were already taxed. 

 

If you report your non-deductible contributions, you will have a "basis" in your IRA, and a proportional share of future withdrawals will be non-taxable.  But for various reasons, it is better to make non-deductible contributions to a separate Roth IRA, if you are eligible. 

nblandfo
Returning Member

Non-deductible contributions to Traditional IRA. 8606 or not?

Thanks. That clears things up for me. Much appreciated

Non-deductible contributions to Traditional IRA. 8606 or not?

I had taken a traditional IRA distribution in 2021, and then took that money and converted it to a Roth IRA.  Upon using the software a question was asked If I had made any nondeductible IRA contributions in previous years?  I wanted to know the reason for the question, and If I should go back through all my 1040s in past years to check?

Non-deductible contributions to Traditional IRA. 8606 or not?


@sonzoil wrote:

I had taken a traditional IRA distribution in 2021, and then took that money and converted it to a Roth IRA.  Upon using the software a question was asked If I had made any nondeductible IRA contributions in previous years?  I wanted to know the reason for the question, and If I should go back through all my 1040s in past years to check?


If you made non-deductible IRA contributions in the past, then a portion of any current or future distribution (or conversion) would be tax-free since it was already taxed.  You would have a form 8606 as part of your tax return for every year you made a non-deductible IRA.  Your most recent form 8606 will also have the total of any non-deductible contributions, although the IRS recommends you save all the 8606s generated from non-deductible contributions, in case you need them to prove that part of your current and future withdrawals are tax-free.   

 

If you never made non-deductible contributions, then all your current withdrawals or conversions are taxable.  

Non-deductible contributions to Traditional IRA. 8606 or not?

So again form 8606 is something I would have generated, and not something sent by the plan administrator for the IRA?

Non-deductible contributions to Traditional IRA. 8606 or not?


@sonzoil wrote:

So again form 8606 is something I would have generated, and not something sent by the plan administrator for the IRA?


Correct.  If you made a contribution to a traditional IRA, and chose not to take the tax deduction, or were unable to take the tax deduction due to your income or other limitations, you would generate a form 8606 as part of your tax return. 

Non-deductible contributions to Traditional IRA. 8606 or not?

Thanks again for the information!

Non-deductible contributions to Traditional IRA. 8606 or not?

Another question on form 8606.  If I review my previous years returns, is there a line on 1040, that shows I made a NON deductible IRA contribution for that year? or is it not shown on the 1040, but only a generated, attached 8606 form?

Non-deductible contributions to Traditional IRA. 8606 or not?


@sonzoil wrote:

Another question on form 8606.  If I review my previous years returns, is there a line on 1040, that shows I made a NON deductible IRA contribution for that year? or is it not shown on the 1040, but only a generated, attached 8606 form?


Since it does not change the computation of your tax, I'm pretty sure it will only be reported on form 8606.  That's why taxpayers are advised to keep all their prior forms 8606, in case they need to prove to the IRS that a recent IRA withdrawal should be partly non-taxable. 

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