From Retirement Now Newsletter May 13th 2021

I was reading recently about a tax issue that could affect retirees, causing them to double pay on their taxes. I’ve come across this only a handful of times, but thought it worth sharing.

And the situation reminded me of a historical event that happened before we had instant communications technology across the globe.

On January 8th 1815, Andrew Jackson led the victory in New Orleans during the War of 1812. The irony was the peace treaty to end the war was signed in Belgium a few weeks earlier on Christmas Eve 1814. Thus, in a way it was an unnecessary battle. But global communications being what they were then, the news hadn’t arrived yet in the New World.

Which brings me to the article I recently read.

Did you know it is possible to make non-deductible (i.e. funds that have already had taxes paid on them) contributions into your Traditional IRA?

It happens for individuals who are making employer plan (i.e. 401k, etc) contributions AND they earn too much income. They then get phased out of being able to deduct their IRA contributions on their taxes that year.

So their IRA can actually have contributions inside it that have already had taxes paid on it.

And if the individual does not keep track of this, they could accidently end up paying taxes on those funds when they pull them out of their IRA in retirement.

I like to think of those non-deductible funds (which have already been taxed) as already having a “peace treaty” with the IRS signed on them. There’s no sense in fighting the battle again by paying taxes a second time on them when you withdraw them during retirement.

It’s likely that most people will not have these types of funds inside their IRA. And people that do have these funds in their IRA, they will probably only comprise a small percentage of the overall IRA’s value.

The article states:

“Most money in Traditional IRAs tends to be pre-tax money. Occasionally, however, after-tax amounts find their way into Traditional IRAs via nondeductible contributions… Such amounts represent already-taxed money, which should not be taxed again (when distributed in the future).”

As it is, IRA custodians DO NOT keep track of these records.

So if you’re in the rare situation where you have contributed non-deductible funds into your Traditional IRA you have to be careful of keeping track of this so you can prove it when you begin making withdrawals.

If there’s anything worse than paying taxes, it’s paying taxes twice.

And the IRS doesn’t expect you to pay the tax twice, but it’s up to you to be able to prove the funds were already previously taxed.

The author recommends if you are in this situation to file a Form 8606 on your taxes each year, which shows non-deductible contributions in your IRA, even during years when you don’t make a non-deductible contribution.

That way there will be a record every year on your tax return of how much in non-deductible contributions are present in your IRA, to help you avoid being doubly taxed on those withdrawals when you take them years later during your retirement.

And if you need to go back and track down prior years’ non-deductible contributions into your IRA, possibly going back even decades, the article gets pretty detailed (and complicated in some ways) on how to do that.

Conclusion: Anyway, I hope this helps if you are in the situation that, for whatever the circumstance in the past was that caused you to make a non-deductible IRA contribution, you will be able to avoid paying tax again on those funds that went into your Traditional IRA.

This is just one way that people over pay on taxes in retirement. And if you are concerned about what a possible increase in taxes could potentially do to your retirement portfolio and are seeking help to address this while you still have time, click here to have a 15 minute chat with me to see if we can help you.