By Beverly DeVeny, IRA Technical Expert Follow Me on Twitter: @BevIRAEdSlott
You have made after-tax contributions to your IRA or you have rolled over after-tax funds from your 401(k) or other employer plan to your IRA. How do you and the IRS know what is taxable when you take a distribution?
Every time after-tax money goes into your IRA you should file Form 8606 with your tax return. This is a cumulative form that brings forward your total after-tax deposits from prior years and adds the after-tax deposit from the current year to the total. For this purpose, all of your IRA accounts, including SEP and SIMPLE IRAs are considered one account.
Form 8606 also has the calculation for determining what is not taxable any time you take a distribution from any of your IRAs. You cannot take out only after-tax dollars. You must use the pro-rata rule for your distributions. Each distribution will be partly taxable and partly tax-free (think of it as cream in your coffee). If 1% of all your IRAs consists of after-tax monies, then 1% of your distribution will be tax-free. The formula for this calculation is also on Form 8606 and you should file the form with your tax return in any year you take a distribution.
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