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Will distribution from IRA Contribution be taxed?

Last Updated February 19, 2011

Question: 

I just put $6,000 in a traditional IRA CD as a contribution. These were funds previously taxed. When I withdraw (distribute) these funds will they be taxed again?

 

Answer: 

SHORT ANSWER: When you withdraw this $6,000, it will not be taxed unless you take a tax deduction for it on your tax return.

DETAILED ANSWER
I am expanding my response to include some information that you may already know, but could be of benefit to others who are unfamiliar with how IRAs work.
A traditional IRA IRA is funded with funds that have already been taxed. However, if you are eligible, you can take a tax deduction for the contribution amount, which in effect, makes it ‘pre-tax’ dollars. To determine if you are eligible to take a deduction for your contribution, see the article: Active Participant Status–Can You Deduct Your IRA Contribution?
If you take a tax deduction for your contribution, the amount is taxed when it is withdrawn from your traditional IRA.
If you do not take a tax deduction for your contribution, the amount is considered a nondeductible contribution and is not taxed when withdrawn from your traditional IRA: CAUTION HERE!!!!!!!!!!
  • CAUTION #1: Remind your tax preparer to file IRS Form 8606 to report this contribution as nondeductible, so that the IRS knows it should not be taxed when withdrawn from your traditional IRA. Form 8606 must also be filed for any year that you take a distribution ( if you made a nondeductible contribution to your traditional IRA)
  • CAUTION #2: Distributions of the earnings on those contributions are taxable
  • CAUTION # 3: If you have other traditional IRAs, SEP IRA and/or SIMPLE IRAs, any distribution from any of your traditional IRA, SEP IRA and/or SIMPLE IRA will include a prorated amount of your pre-tax and after-tax balance.  For example, assume that you have other traditional IRA, SEP IRA and/or or SIMPLE IRA balances totaling $10,000, all of which is pre-tax.  Your total balances for all of your traditional, SEP and SIMPLE IRAs would now be $16,000- which comprises of 37.5% after-tax amounts and 62.5% pre-tax. Assume too that you take a distribution of $6,000 from this IRA CD. Under the IRA rules/regulations, the $6,000 will include $2,250 after-tax (nontaxable) amount and $3,750 pre-tax (taxable) amount.
 REMINDER: You cannot make a traditional IRA contribution beginning the year that you reach age 70 ½. 

Answer provided by Appleby Retirement Consulting Inc. Appleby Retirement Consulting Inc provides Consulting, Coaching and Content on IRAs and other retirement plans to Financial, Tax and Legal professionals.