Tax Consequences of a Nondeductible IRA Distribution

  Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance      Updated October 25, 2018
  Written by: Mark Kennan

A nondeductible individual retirement account (IRA) refers to a traditional IRA containing nondeductible contributions. Knowing how to figure the tax implications of a distribution from a traditional IRA containing nondeductible contributions helps you budget how much you need to withdraw to cover the taxes you owe when you file your return. These non deductible IRA withdrawal rules will help ensure that you don't run afoul of the IRS during tax season.

Tips

  • If you have made a series of nondeductible contributions to your IRA throughout your working years, you will likely be able to withdraw these funds at a later point in time without having to pay tax on them. Early distribution penalties will still apply, however.

Finding More About Nondeductible IRA Functions

Typically, people contribute to a traditional IRA to take advantage of the tax deduction for the contributions. However, if you are covered by an employer plan and make too much money, or if you simply elect to make a nondeductible contribution, you do not deduct the contribution on your taxes. The money still grows tax-free, but when you take a withdrawal, the part of your distribution comprised of those nondeductible contributions comes out tax-free because you did not claim a tax deduction for them. It is in your best interest to keep tracking non deductible IRA contributions throughout your working years, however.

Looking at Taxable Portion

To figure the taxable portion of your nondeductible IRA, you first have to figure out how much you have in the account from nondeductible contributions. Then, divide the amount of nondeductible contributions by the account total to find the portion of your nondeductible IRA distribution that comes out tax-free. The remaining portion of your nondeductible IRA distribution is subject to income taxes and penalties.

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Obtaining Early Distributions from Nondeductible IRAs

If you take an early distribution from your nondeductible IRA, you must pay a 10 percent early withdrawal penalty. However, the penalty only affects the taxable portion of the distribution. For example, if you take a $3,700 early distribution and only $2,000 is taxable, the traditional IRA early withdrawal penalty would only be $200 rather than $370. Like any other IRA distribution, you can avoid the early withdrawal penalty if you have a qualifying exception such as college expenses, a permanent disability or medical expenses above 7.5 percent of your adjusted gross income.

Reporting a Nondeductible IRA Distribution

When you take a distribution from a nondeductible IRA, you first complete Form 8606, Part I. This documents for the IRS how you figured the taxable and nontaxable portion of your IRA distribution. If you have not turned 59 1/2 years old, you must complete Form 5329 because your distribution is not qualified and therefore you owe a penalty. Finally, file your tax return with Form 1040 and report the nontaxable portion, the taxable portion and, if applicable, the early withdrawal penalty.

About the Author

Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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