What Is an IRA Basis?

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Normally, your contributions to an individual retirement account are tax free. The tax bite comes when you retire, start taking withdrawals and pay tax on them along with your other income. It's possible to make nondeductible contributions to your IRA, however. Those contributions become your basis.

IRA and Income Limits

At the time of writing, you can deduct up to $5,500 a year in IRA contributions from your taxable income. If your employer enrolls you in a retirement plan — a 401(k), for instance — that can lower your deduction. For example, if you're filing as a single person and your modified adjusted gross income, or MAGI, is greater than $60,000, you get a lower IRA write-off. If your MAGI equals $70,000, you can't deduct any IRA contributions. You can calculate your MAGI with a worksheet in Internal Revenue Service Publication 590-A.

If you don't have a retirement plan but your spouse does, the cutoff for deducting IRA contributions is higher, but there is one.

Nondeductible Contributions

Losing the write-off doesn't stop you from putting money into your IRA. Even if you get no write-off at all, you can still contribute up to $5,500 to this retirement fund. Once you make a contribution, deductible or not, any interest it earns is tax exempt until you start withdrawals. If you invest your nondeductible contributions in a certificate of deposit, for instance, the interest it earns is tax-free until you withdraw it from the IRA.

Warning

  • If your compensation for the year is less than $5,500, you can only contribute up to your compensation. The IRS defines compensation to include salaries, wages, self-employment income and alimony, but not interest, dividends or rental income.

Withdrawals and Rollovers

When you make withdrawals from an IRA, you treat your basis differently from deductible contributions and interest. You already paid tax on the nondeductible contributions, so when you withdraw them, they're tax free. IRS Publication 590 explains how to figure the nontaxable percentage of each withdrawal you take from your account. You have to follow the formula. Even if it's better for your taxes to withdraw everything from the basis this year, that's not an option.

If you convert some of your traditional IRA to a Roth, you have to pay income tax on the conversion: A $5,000 IRA-to-Roth transfer counts as $5,000 in added income, for instance. However the part of your conversion that comes from the basis is tax free. As with withdrawals, you can't take money just out of the basis and leave the taxable funds in the account.

If you have multiple IRAs, the tax calculations use the combined basis in all your accounts, no matter which account you actually withdraw from.

Inherited IRAs

If you inherit an IRA, that has no effect on the basis. Say your mother dies and leaves you a $40,000 IRA with a $12,000 basis. When you inherit, the account still has a $12,000 basis. You calculate the basis on a withdrawal just as your mother would have. You don't factor in the basis from your other IRAs when figuring out how much of the withdrawal from the inherited IRA is taxable. The exception is if you inherit the IRA from your spouse and elect to treat it as your own account — something allowed to spouses but no other beneficiaries.

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