How Do I Know If My IRA is Taxable?

Tax regulations surrounding IRAs can be complex and ever-evolving, so it is advisable to speak to a tax expert prior to taking any steps with your own account.

An IRA’s cost basis can be understood in terms of a fraction: where the numerator equals your cumulative nondeductible contributions and the denominator equals all traditional IRA balances combined.

1. Cost basis

IRA holders are generally responsible for keeping track of their cost basis and reporting capital gains or losses when selling investments. Depending on the nature of their asset, investors can use either first-in, first-out (FIFO) or specific share identification methods to establish initial purchase cost as well as subsequent sale cost.

Individuals with traditional IRAs should review the 1099-Bs issued from brokerage firms following each sale to verify the reported cost basis is correct. Investors should pay close attention to how shares were priced when sold and remember some investments may not be eligible as investments (such as precious metals or real estate).

Keep track of your IRA’s tax basis isn’t just good practice; it could save money when it comes time to take distributions or assist with strategic retirement planning. There are various methods of monitoring it such as spreadsheets, financial software or working with an advisor who specializes in this area.

2. Nondeductible contributions

While most traditional IRA contributions are pretax, certain taxpayers make after-tax contributions (either through nondeductible contributions or rolling over after-tax amounts from SEP or SIMPLE IRAs). To calculate the taxable portion of an IRA withdrawal, it’s necessary to know how much “basis” (pretax contributions) there are and what portion belongs to after-tax contributions.

Taxpayers looking to quantify and prove prior-year Traditional IRA contributions can access old account statements or use IRS Form 5498 filed by custodians each year and sent to clients. Taxpayers needing proof can request copies of previous year tax returns free from the IRS or pay $50 per return already owned.

If a Roth IRA owner withdraws funds prior to age 59 1/2, they must include it in their taxable income and may incur a 10% penalty tax, unless an exception applies. To reduce or avoid this tax penalty, rollovers should only occur with financial institutions that permit direct trustee-to-trustee transfers.

3. Rollovers

Transferring assets from qualified plans (401(k), money purchase plans, profit sharing or defined benefit plans) into an IRA preserves their tax-deferred status; however not all rollovers are equal and it’s essential that you adhere to IRS rules on rollovers for an effective rollover experience.

Direct transfers offer the safest method for rolling over assets, whereby your old plan’s trustee sends a check directly to the trustee of your new account – this is known as trustee-to-trustee transfer.

Indirect transfers may be more risky because you only have 60 days to deposit the funds into your new account or face income tax and penalties for their distribution. When choosing between this option and direct transfers, consider your tax bracket and future projections when choosing which is the most efficient plan for you – our advisors at Thrivent Financial can help devise strategies to maximize tax efficiency with your IRA account.

4. Withdrawals

As you get older, your IRA requires required minimum distributions (RMD). Otherwise, the IRS could impose a substantial tax penalty against you.

Your RMD depends on your age and life expectancy, both of which are detailed by the IRS in Publication 590-B. Using its uniform life table, you can calculate what your RMD should be each year.

Once you reach age 59 1/2, withdrawals from an IRA will generally incur ordinary income taxes unless they qualify as exempted expenses, such as unreimbursed medical costs that exceed 7.5% of adjusted gross income or purchasing your first home.

Calculating your taxable withdrawal can be done easily by looking at box seven on your custodian or trustee’s Form 1099-R. However, if you make in-kind withdrawals such as stocks from an IRA account, such as using the cost basis records to figure out the price basis.


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