How Do I Know If My IRA is Taxable?

An individual retirement account (IRA) enables you to invest for retirement with some unique tax benefits, including immediate tax deduction, tax-deferred growth and potential tax-free withdrawals in retirement.

How your IRA is taxed depends on its usage and accurate tracking of its basis.

Contributions

Determining whether an IRA withdrawal is taxable depends on various factors, including whether contributions were tax deductible. Clients should keep Form 5498 from their IRA administrators for each year they contribute and review previous tax returns to determine how much deduction was allowed.

Nondeductible IRAs may not be as popular, but they offer tax benefits that could help investors save in retirement. Investors pay taxes only on earnings generated by investments held within a nondeductible IRA and not on contributions made directly.

Investors can maximize their retirement savings by contributing to both a traditional IRA and Roth IRA each year, with this year’s contribution limits set at $6,000 ($7,500 if 50 or older). Furthermore, investors can add a Simplified Employee Pension Plan (SEP), with higher contribution limits than traditional IRAs; IRS updates these periodically; SEPs are tailored toward small business owners and self-employed individuals alike.

Withdrawals

Your tax liability when withdrawing money from an IRA depends on various factors, such as whether your contributions were tax-deductible and how it will be used; your age and purpose for withdrawing. Typically, income taxes will apply; however there may be exceptions to this rule.

Some of these exceptions include:

To calculate how much of a withdrawal is taxable, it’s necessary to know how many nondeductible contributions were made to an IRA in question. To do this, first calculate its basis by subtracting all contributions from current balance and multiplying that figure by 1.

When helping clients move IRA funds between trustees, always arrange for a trustee-to-trustee transfer to avoid making any errors that could incur penalties from the IRS. Also help your client understand 72(t) regulations which can sometimes trigger penalties in certain situations.

Required minimum distributions (RMDs)

Once an account holder reaches RMD age, they are required to withdraw a certain amount annually from their retirement accounts. The exact amount depends on dividing prior year-end account balance by life expectancy factor published by IRS; your custodian should provide you with a worksheet so you can easily calculate it.

Make sure to take your RMD on time each year, because the IRS imposes severe penalties if you miss it by more than 10 years – for instance, they levy an excise tax equivalent to 50% of what should have been withheld from you as your initial RMD withdrawal.

RMD rules can differ depending on who is designated as your beneficiary. For instance, if your spouse is the only designated beneficiary who is more than 10 years younger than you then use the IRS Joint Life and Last Survivor Expectancy Table rather than Single Life Expectancy Table to calculate RMDs.

Taxes

Individual Retirement Accounts (IRAs) enable individuals to save for retirement outside of a workplace plan, by investing in traditional IRAs, Roth IRAs and SEP or SIMPLE IRAs based on their needs and circumstances.

Some IRAs contain nondeductible contributions that must be included as taxable income when withdrawals occur. Taxation of these accounts can be determined by dividing the total nondeductible contributions by their current value; then multiplying that fraction times withdrawals to determine their taxable amount.

To check if your IRA contains nondeductible contributions, take a close look at each year-end statement for all of your accounts and file Form 8606 annually when making nondeductible contributions; generally this must be submitted before the tax-filing deadline of that particular year; you may also be able to obtain copies of past tax returns from the IRS free or for a fee.


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