My husband has an employer-sponsored plan and every year we contribute to a spousal traditional IRA under my name. Last year, when we were filing our 2011 taxes, we contributed to this IRA both for tax year 2011 and tax year 2012. The contribution for 2012 was $6000. Now we are filing our 2012 taxes and our CPA tells us that our household income is over the limit, making our contributions non-deductible. Since it is already mixed with before tax money, what should I do now? Can I hold an IRA account with before and after-tax money? Is it considered an “excess” contribution?
It may sound unbelievable, but you can actually have both pre-tax and after-tax money in the same Traditional IRA so there is nothing you need to do right now to fix your situation. It is important in these situations to keep track of the “basis” of your contributions (the amount of money that has already been taxed) so that you don’t end up paying double taxes when you withdraw or convert to a Roth IRA.
Here’s an example:
- You contribute $6,000 to a Traditional IRA in 2010 (tax deductible)
- Total: $6,000 pre-tax
- You contribute $6,000 to a Traditional IRA in 2011 (tax deductible)
- Total: $12,000 pre-tax
- You contribute $6,000 to a Traditional IRA in 2012, but find out your income is too high to take the deduction (not tax-deductible)
- Total: $12,000 pre-tax, $6,000 post-tax
- Years later your account has grown to $50,000 in value
- Taxable withdrawal = Withdrawal amount minus “basis” that has already been taxed
- Taxable withdrawal = $50,000 – $6,000 = $44,000
- The $44,000 you are being taxed on is your $12,000 pre-tax contribution plus $32,000 in gains on both pre and post-tax contributions.
So basically you need to keep track of how much of your account you’ve already paid taxes on (the non-deductible portion). The IRS has a form for this (Form 8606). I know it sounds complicated, but if you use tax software like TurboTax or H&R Block, it’s just one more simple question to answer.
One more thing to be aware of is that when you withdraw or rollover your Traditional IRA assets, you don’t get to choose which assets you rollover. The government requires that you rollover on a “pro-rata” basis. This means that if 75% of your assets are pre-tax and 25% are post-tax, you will be taxed on 75% of your rollover/withdrawal amount. You don’t get to designate that you are withdrawing the 25% that’s post-tax.
To answer your other question, no, your situation would not be an “excess” contribution. Assuming you are 50 years old or older, your $6,000 contribution was the allowable amount (under 50 could contribute $5,000 in 2012; the contribution limits go up in 2013). If you had contributed to a Roth IRA and found yourself above the income limit, then you would have had “excess” contributions that needed to be removed. But the only way to have “excess” contributions to a Traditional IRA is to exceed the $6,000 (or $5,000) limit, which you did not do.
About the Author
Joanna D. Pratt, CFA is an experienced institutional investor. She holds a bachelor’s degree in economics and certificate in finance from Princeton and an MBA from Stanford.
Have an investing question? Email it to email@example.com.
Photo credit: Tax forms from Shutterstock