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How To Handle Nondeductible IRA Contributions

A great way to shoot yourself in the tax foot is when you make too much money to deduct your IRA contributions but fail to keep accurate records.

For investors who take distributions from their IRAs, they may be surprised to find out they could be paying less tax on those distributions than they need to had they just taken a moment to track their nondeductible IRA contributions.


You and your spouse are both covered by a retirement plan at work, like a 401(k), and contribute to your respective IRAs. Assuming married filing jointly tax status, if your Modified Adjusted Gross Income (MAGI) is above $129,000 (2022 threshold), you cannot deduct your IRA contribution.

What happens here is your IRA contrition is made with dollars you've already paid taxes on. We call these dollars "post-tax". If you're unable to deduct this contribution because you exceed the MAGI threshold, that contribution retains its post-tax status inside your IRA.

Over time, that contribution grows inside your IRA because you invest it. However, now you have a mix of dollars in the IRA that should be taxed differently. This is where it starts to get a bit complicated.

When you begin taking distributions from the IRA, the original IRA contribution dollars should not be taxed because 1. you already paid taxes on that money when you were employed and 2. you never received a tax benefit from the contribution deduction because your MAGI was too high.

The dollars in the IRA that represent growth have never been taxed. Therefore, the IRS wants their cut on those dollars you haven't yet paid ordinary income taxes on.

Sidenote- this tax deferral on the growth inside of an IRA is what makes this type of retirement account advantageous over saving in a regular brokerage account.


Where investors in the scenario above get whacked is when they start taking distributions from their IRAs.

Unless you claim otherwise, the IRS considers all dollars distributed from an IRA to be fully taxable at Ordinary Income rates. Unfortunately for most folks, the ordinary income rate is normally their highest tax rate paid.

The issue with IRA distributions is if you don't track nondeductible contributions, you'll pay taxes on those dollars twice; once when you initially recognize the Earned Income and then again when those dollars come out of the IRA as distributions. Ouch!

Here's some math to illustrate what can happen.

You and your spouse recognize $200,000 of MAGI and each makes $7,000 nondeductible IRA contributions. A decade passes and now you're retired and that $14,000 has doubled to $28,000.

You take out the $28,000 from your IRAs as retirement income but fail to recognize half of that distribution consists of post-tax dollars you never deducted (because your income was too high) and TurboTax or your tax preparer says you must pay tax on the entire $28,000.

Assuming you're in the 12% federal marginal tax bracket in retirement, this mistake ends up costing you $1,680. If you're a retiree in the 22% bracket, you unknowingly overpaid by $3,080.

Now imagine this scenario extends over multiple years of not tracking nondeductible IRA contributions. Then apply the same multi-year scenario to your state tax bill.

You could easily end up overpaying your tax bill by tens of thousands of dollars all said and done.


If you believe you fall (or will fall) into the scenario above, do yourself a massive favor and understand if your IRA contributions are/were deductible or not. The IRS has easy-to-follow guidance HERE.

Assuming at least some of your current and former IRA contributions aren't deductible, the actual method of tracking is actually quite straightforward.

You file Form 8606 as part of your 1040 tax return.

Form 8606 covers a few items, including IRA contributions. For most taxpayers, they likely filed this form by default simply by telling TurboTax or their tax preparer they made IRA contributions.

This is the best-case scenario because what it allows you to do is go back and tally up all the nondeductible IRA contributions you made over the years to determine your IRA account's "basis". In finance, basis represents any amount not subject to taxes.

Once you've determined your IRA account's basis, you can compare this amount to the IRA balance which ultimately determines how much of your IRA distribution should be taxed.

Some more math...

Let's say you made $40,000 worth of nondeductible IRA contributions (the basis) and have a current IRA balance of $400,000.

This means 10% of your IRA = basis. This amount should not be subject to taxation when distributed.

The way the IRS treats your 10% basis is they apply it pro-rata to every IRA distribution.

I'm simplifying things a little bit, but essentially, if you took out $10,000 of your $400,000 IRA, $1,000 of the $10,000 distribution would be tax-free, i.e., the 10% representing basis. Assuming a 12% federal marginal income bracket, properly accounting for IRA basis reduces your taxable income by $1,000 which saves you $120 on your federal tax bill.

The higher your basis and/or the more you distribute from your IRA each year, the more tracking this stuff helps you.

One of the challenges you're up against is TurboTax isn't smart enough to know what your IRA basis is unless you tell it. In addition, if you let TurboTax grab your TD Ameritrade investment-related tax information (yes, you should do this), TD and most other brokerage firms are going to report 100% of your IRA distributions as taxable.

It's not their responsibility to keep track of this. It's yours.

Another potential challenge is when you've done a good job tracking IRA basis but then change tax preparers or the software that you use. You need to remember to tell the new tax preparer or software system what your IRA basis is otherwise all the tracking you've done is likely lost.

For retirees taking IRA distributions and working with TurboTax, under the Wages & Income section, as you click through the IRA distribution mechanics detailed on Form 1099-R, there is an option to adjust your IRA basis.

This is where you need to deviate from what your 1099-R says and what TurboTax assumes. Both will assume your IRA distribution is fully taxable.

Specifically, you should use TurboTax's "EasyGuide" to enter basis if it's your first time declaring an IRA distribution. It'll look like this:

Once this info is entered, TurboTax will track it for you each year.

Alternatively, if you pay a tax preparer, they have the ability to make sure basis is entered properly. You just can't rely on them to ask you about IRA basis. Some will, and some won't bother. You need to be smart enough to inform them so they don't unknowingly trigger that double taxation scenario mentioned earlier.

Don't just assume your tax preparer knows about your IRA basis or remembers to track it. By and large, a tax preparer's goal is to get your return done as quickly as possible in the extremely limited amount of time they're given each year. They're humans (mostly), and as such need direction and information to do their job well.


If you failed to file Form 8606 each year you made nondeductible IRA contributions, I hate to inform you but you're in for some pain.

First, you need to determine which years you made a nondeductible IRA contribution and failed to file Form 8606. This is going to take some time and give you a headache.

Do it anyway.

Next, the IRS says you should file Form 8606 along with an amended return for every year you missed. Their official guidance can be found HERE (almost halfway down), but a few tax-related blogs I came across suggest an amended return isn't necessary.

Based on this conflicting information, you'll want to cough up some money to a tax preparer that has expertise in this specific area.


No polite way to say this, but don't screw this up! You shouldn't assume your tax preparer is asking all the right questions or tracking nuance on your 1040.

If you're a DIY tax preparer, you need to spend time educating yourself on our ridiculously complex tax structure so you get things right. The problem with this statement is that you don't know what you don't know!

It's impossible to fix a problem when you're unaware of its existence. That said, DIY tax folks might want to sit down with a tax planner (not necessarily a tax preparer) every few years to talk shop.

Also, you need to understand the relationship between your brokerage firm, your IRA account, and your tax software/tax preparer. Even if you pay a tax preparer to complete your returns, you still need to pay attention to details and effectively communicate with them.

If you think you might fall into the nondeductible IRA contribution scenario I covered throughout this post, I highly recommend you get your numbers sorted PRIOR to beginning distributions from your IRA.

Getting organized is what we do for clients at Aspen Leaf Wealth Management, so if you want to discuss your situation use the "Contact" link at the top right of this page to start a dialogue.


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