Tax Consequences of a Nondeductible IRA Distribution

Taxes can get complicated with nondeductible IRAs, but here's what you need to know.

Dec 5, 2015 at 10:08PM

Most people use traditional IRAs to make deductible contributions that result in immediate tax breaks. However, some taxpayers aren't eligible for deductions on their traditional IRA contributions because of having too much income. Any taxpayers can make a nondeductible contribution to a traditional IRA, but doing so has complicated tax consequences that require careful consideration. Let's look more closely at exactly how distributions from nondeductible IRAs get taxed.

Nondeductible IRAs and tax basis
With most traditional IRAs, the tax consequences are simple: all distributions are taxable. That's because if you get an upfront deduction on your IRA contribution, then the IRS wants to get its tax revenue back when you withdraw money from your account in retirement. Put another way, since there's no after-tax money in the account, there's no reason not to go ahead and tax your distributions in retirement.

With nondeductible contributions, though, it gets trickier. Essentially, nondeductible IRAs include some after-tax money, and the IRS gives you credit for the fact that you already paid tax on that portion of the IRA. At the same time, it needs to collect taxes on the portion of the IRA that came from the income and gains that your nondeductible contribution generated between the time you made it and the time you make the withdrawal.

Fortunately, the rules that govern this process are as simple as the situation allows. The IRS essentially treats each distribution you make as being partially from the nondeductible contribution you initially made and partially from the income and gains it generated. To figure how much comes from which part, you have to track how much of your total IRA balance came from nondeductible contributions and how much came from income, and then take the correct proportion from each.

A simple example should make it clearer. Say you contribute $5,000 to a nondeductible IRA. Over the course of five years, it grows to $8,000. You retire and take a distribution of $2,000. To figure out how much is taxable, you can see that $5,000 out of $8,000 in the account came from the original contribution, which works out to five-eighths of its total value. So five-eighths of $2,000, or $1,250, will be free of tax. The remaining $750 represents the three-eighths of the account that came from income and gains, and it gets included in your taxable income.

The key, though, is that you have to keep track of contributions and distributions for future years as well. Unless you clean out the account in one fell swoop, nondeductible IRAs require an accounting hassle that deductible IRAs avoid.

Even with the extra hassle, nondeductible IRAs can make sense in certain situations. By remembering to treat a portion of your distributions as coming from your original nondeductible contribution, you'll ensure that you won't get unfairly double-taxed on your withdrawals in retirement.

The $15,978 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. In fact, one MarketWatch reporter argues that if more Americans knew about this, the government would have to shell out an extra $10 billion annually. For example: one easy, 17-minute trick could pay you as much as $15,978 more... each year! Once you learn how to take advantage of all these loopholes, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how you can take advantage of these strategies.

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in the Foolsaurus. Pop on over there to learn more about our Wiki and how you can be involved in helping the world invest, better! If you see any issues with this page, please email us at Thanks -- and Fool on!

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers