What’s Not Taxable of your IRA and 401(k) Distributions?
Generally, your IRA and or company 401(k) distributions are taxed as ordinary income. That’s because you funded them with tax-deductible contributions and all the earnings of these contributions have been tax-deferred. So nothing has been taxed. Taking a distribution before turning 59½ will add a 10% penalty tax to the income tax.
Nevertheless, you may have made some ‘after-tax’ contributions to them, and those – not their earnings – will come out tax free. So let’s see how this to handle these.
Taxable and non taxable distributions for company-administered plans such as a 401(k)
This is pretty easy because it’s your employer who is responsible for tracking both your tax deductible and after-tax contributions to the plan. They’ll report those amounts to you, either on your statements or on a 1099-R when you take a distribution from the plan.
IRA distribution
You’re the administrator of your IRA. So keeping track of after-tax contributions is your job. That’s done on IRS Form 8606 each year you make an after-tax contribution and each year you take an IRA distribution.
This form – each time it’s filed - carries forward the total of prior year after-tax contributions and adds them to any current year contribution. It also formulates the non-taxable portion of any distribution you take in the year. And, of course subtracts out that amount from the total after-tax contributions among your IRAs. Normally, form 8606 is attached to your tax return.
The non-taxable portion of your IRA distributionsduring the year is the ratio of all your after-tax contributions (from your latest Form 8606) divided by the total value of your IRAs. No, you don’t get to take out just the ‘tax-free’ part! Each time you take an IRA distribution, part is taxable, part is return of after tax money (not taxable).
What if you forgot to file your Form 8606 over the years? Just get the form and its instructions; it’ll give you some suggestions on documentation you can use to substantiate your prior after-tax contribution amounts. If you think the amount of after tax contributions you have forgot to document is significant, then get help form a tax professional so that you don’t need to pay tax twice when you take distributions.
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Tags: 401k distribution, 401k distriubution, ira distribution
April 19th, 2009 at 3:33 pm
Since the ira makes you keep track i like the roth best. No need to fill out any forms it is all tax free. I even plan to transfer rest of my regular iras out this year because they have droped in price and swith the stocks over to a roth.
Best etf funds lits last blog post..Oil etf.
August 1st, 2009 at 12:07 pm
Thanks for the information. My 401k and taxes has always confused me. I barely have the ability to keep up with the basic math related to my apartments, let alone the complex tax issues related to the rentals and my retirement.
August 31st, 2009 at 2:29 am
Definitely good advice for working out the minimal impact of the change of age. It is not always easy to start to do complete the Form 8606 if you haven’t done it previously so the advice to use a professional, especially for large amounts of documentation, is really important.
September 17th, 2009 at 3:31 am
@ Best etf funds lit: It is subjective whether you opt for IRA or roth. Not everyone would choose roth over IRA irrespective of prices. And you never know who saves what by selecting which option. The most advisable thing is to consult a tax professional who can help strategize your complete tax filing in a way that helps you save more.
September 22nd, 2009 at 3:21 am
Interesting article, I can see why the 401k are eating me up a little bit, but i cant really decide what to invest that money into other then my 401k any help?
October 11th, 2009 at 5:18 pm
True of a regular 401k and IRA, but do not forget that Roth IRAs and 401ks work the opposite way, you pay taxes up front but you do not pay a cent when you take the money out!
October 14th, 2009 at 2:20 am
How about CD’s? or maybe even mutual funds? The stock market can be scary nowadays but it seems like now is the time to buy!
October 22nd, 2009 at 7:55 am
[...] What’s Not Taxable of your IRA and 401(k) Distributions? [...]
October 26th, 2009 at 2:09 pm
Good overview of the tax implications of an IRA distribution. Personally I’m a big fan of the roth. If you are young this is especially true for there being more advantages for investing in a roth. This is because you will be in a higher income bracket once you are older (ideally.) This makes it better to be taxed when you are young in your career rather than at the end.
December 10th, 2009 at 8:49 am
I understand from a letter I received from the IRS that for this year (tax year 2009) I am not required to make any distribution of my IRA.