Rollover IRA distinction between pre-tax and post-tax money

We read in a Discussion @ Morningstar:  I have a rollover IRA from a previous employer 401k. So far so good. All pre-tax money and happily trading with it at TD. However I wanted to deposit more money into that rollover IRA.  Since the 80s that is possible. Depending on one's income that deposit would be either tax deductible or not. In my case it isn't. And there is the dilemma:

I couldn’t believe what my accountant told me so I called the man directly (IRS rules and regulations group).

It seem one has to keep track of the deposits so that when the no-penalty distribution time comes (retirement age) the deposits made during the lifetime of the rollover IRA which were ineligible as tax deduction will NOT be taxed while the money sourced as pre-tax from the old 401k will be taxed upon normal distribution.

What?

IRS allows mixing IRA and Roth IRA mechanics into the same account?  And the only proof what's taxed and what isn't will be decade old 80xx forms for all those deposits and ONLY those that couldn't qualify as deduction due to high income.  What are they smoking up there at the treasury department?

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Re: Rollover IRA distinction between pre-tax and post-tax money

12-14-2013, 6:56 PM | Post #3497043

 Bubba198:

It seem one has to keep track of the deposits so that when the no-penalty distribution time comes (retirement age) the deposits made during the lifetime of the rollover IRA which were ineligible as tax deduction will NOT be taxed while the money sourced as pre-tax from the old 401k will be taxed upon normal distribution.

IRS allows mixing IRA and Roth IRA mechanics into the same account?

And the only proof what's taxed and what isn't will be decade old 80xx forms for all those deposits and ONLY those that couldn't qualify as deduction due to high income.

We actually ran afoul of these rules ourselves, but if you take steps now it's really not that bad.

I our case we neglected to file the 8606 form in 1994 and did not discover the error until 2007. That was the only year we missed a required filing of 8606. Note there is also a penalty for not filing 8606, but as long as your taxes were calculated correctly you could ask for the penalty to be waived. We did ask and the penalty was waived.


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Re: Rollover IRA distinction between pre-tax and post-tax money

12-14-2013, 7:47 PM | Post #3497046

Thank you; the form is 8606; I was incorrect with the 80xx; one way or another IMHO this is total stupidity! So I will be keeping a stack of 8606s and hopefully twenty years from now I don't end up paying income tax again on all those deposits.. LOL

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Re: Rollover IRA distinction between pre-tax and post-tax money

12-14-2013, 8:48 PM | Post #3497051

Traditional IRA can have deductible [pre-tax] and nondeductible [after-tax] contributions. Form 8606 keeps track of the two types on contributions. If not tracked properly, the IRS may just tax all withdrawals [in addition to penalties], so it is in your interest to save the Form 8606 [or file them annually anyway even if not required].

Also, a nondeductible [after-tax] contribution to Traditional IRA doesn't make it a Roth IRA.

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Re: Rollover IRA distinction between pre-tax and post-tax money

12-14-2013, 10:24 PM | Post #3497069

Thanks yogibearbull

So I am puzzled: fine; the after-tax IRA contributions won't be taxed one day but what about the growth of the account which can be attributed to those after-tax contributions? In fact how can one derive any rational conclusion of what growth was the product of which contribution? That's crazy.

Since this isn't Roth, as you pointed out where ANY groth is tax-free at the end then what happens here?

Does one just get dollar-for-dollar tax-free distribution for those after-tax contributions and then everything else is taxed at present brackets of the future retirement tax climate?


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Re: Rollover IRA distinction between pre-tax and post-tax money

12-15-2013, 12:06 AM | Post #3497071

"So I am puzzled: fine; the after-tax IRA contributions won't be taxed one day but what about the growth of the account which can be attributed to those after-tax contributions?"

growth of those after tax contributions will be taxed in a trad IRA.  Only the principal goes untaxed.  For the growth to be untaxed, it woud bhave to be a Roth IRA.

"Does one just get dollar-for-dollar tax-free distribution for those after-tax contributions and then everything else is taxed at present brackets of the future retirement tax climate?"

yes.

Since you have a trad IRA, you cannot contribute to a backsdoor Roth , and have it be untaxed.  You would be better off using a chunk of money as taxes to do a partial conversion of your trad IRA to a Roth rather than making a non-deductible contribution to a trad-IRA. 

Until 2009  I never had a trad IRA since I could not deduct my contributions, because it did not seem worth it.  A taxable account had better features than  non-deductible trad-IRA.  I only use my trad IRA for doing back door Roth contributions.  That trad IRA only has money in it for about one week a year.


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Re: Rollover IRA distinction between pre-tax and post-tax money

12-15-2013, 7:19 AM | Post #3497084

In Traditional IRA, you are taxed on the earnings and gains of the nondeductible [after-tax] contributions. Form 8606 keeps track of your basis - your previous nondeductible contributions plus more nondeductible contributions minuswithdrawals [proportionally allocated to deductible and nondeductible portions forall Traditional IRAs]. That basis is the magical number to keep/save and if you will not keep track of it, the IRS may assume that your basis is zero., i.e., any withdrawals from Traditional IRAs may be fully taxed.


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Re: Rollover IRA distinction between pre-tax and post-tax money

22 hours, 13 minutes ago | Post #3497116

At the expense of repeating what has already been said...

Each year that you make after tax (non-deductible) contributions to your traditional IRA(s) (TIRA), you must file a form 8606 that shows this after tax contribution. The 8606 is cummulative and will never expire. So in my case, the last year of making a non-deductible TIRA contribution was 1996, and the cummulative total up to that year is shown on that 8606 as $18,000. I still have that last 8606 as it is the only record I have of my cummulative 'basis'. So if I were to make a withdrawal this year and the value of my TIRA(s) at the end of the year (12/31) is $400,000, then 18000/400000 = 4.5% of my withdrawal this year will be a return to me of my basis and non includable as income. I will then have to file another form 8606 this year to adjust downward my TIRA basis, and this will then replace my old 8606.

This gets a bit tricky if you roll over to your TIRA a 401(k) balance that also has basis. Last time I read Pub 590, it said NOT to include this basis in your existing 8606, but to track it separately and use it when a future withdrawal is made. I've never run into this, but frankly, were it me, I would generate a new 8606 on the rollover of a retirement plan with basis, just to keep it straight.

And although you didn't ask so not sure this would apply to you, but it really makes no sense to contribute after tax to your TIRA when you are eligible to contribute to a Roth IRA...i.e. your AGI does not exceed $188,000 (married filing jointly).

BruceM