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Question for the Money Doctors

Question submitted on Apr 12, 2012.

Question

I just discovered I have 401k rollover money and after tax traditional IRA contributions in the same account. I have never been able to take the tax deduction on the IRA contributions.

What will happen when it is time to start taking distributions? Should I separate the funds in two different accounts?

Thanks

Answer

Unfortunately, depending on how long these funds have been comingled, it is unlikely your custodian can identify which gains and losses go to the rollover money compared with the IRA contributions you have made over the years.  That would preclude you from benefitting at this time if you were to separate the funds into different account registrations. 

That being said, when you begin taking distributions, a calculation is done to determine what portion of your annual distributions is taxable.  The after tax traditional IRA contributions you have made should have been reported on your personal tax return form 8606 and the distributions will be reported there as well to calculate the taxable vs. non-taxable portion of the annual distributions. 

Also, if your income becomes lower in the future or you qualify now, you should consider a Roth IRA contribution as opposed to after tax traditional IRAs.  The current threshold for 2012 of modified adjusted gross income begins at $173,000 for Married and Filing Jointly status.  Single or Head of Household status thresholds begin at $110,000.  By utilizing a Roth instead of after tax non-deductible traditional IRA contributions, both the contribution and future earnings will be tax free at withdrawal, as opposed to only contribution itself (subject to the formula).  Additionally, Roth IRAs do not have the Minimum Distribution requirements, so if you don't need the funds, they can continue to grow tax free without having forced distributions as with traditional IRAs.


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