What’s Not Taxable of Your IRA and 401(k) Distributions?

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Generally, your IRA and or company 401(k) distributions are taxed as ordinary income. That's because you funded them with tax-deductible contributions and all the earnings of these contributions have been tax-deferred. So nothing has been taxed. Taking a distribution before turning 59½ will add a 10% penalty tax to the income tax.

Nevertheless, you may have made some 'after-tax' contributions to them, and those – not their earnings – will come out tax free. So let's see how this to handle these.

Taxable and non taxable distributions for company-administered plans such as a 401(k)
This is pretty easy because it's your employer who is responsible for tracking both your tax deductible and after-tax contributions to the plan. They'll report those amounts to you, either on your statements or on a 1099-R when you take a distribution from the plan. 

IRA distribution
You're the administrator of your IRA. So keeping track of after-tax contributions is your job. That's done on IRS Form 8606 each year you make an after-tax contribution and each year you take an IRA distribution.

This form – each time it's filed - carries forward the total of prior year after-tax contributions and adds them to any current year contribution. It also formulates the non-taxable portion of any distribution you take in the year. And, of course subtracts out that amount from the total after-tax contributions among your IRAs.  Normally, form 8606 is attached to your tax return. 

The non-taxable portion of your IRA distributionsduring the year is the ratio of all your after-tax contributions (from your latest Form 8606) divided by the total value of your IRAs. No, you don't get to take out just the 'tax-free' part!  Each time you take an IRA distribution, part is taxable, part is return of after tax money (not taxable).

What if you forgot to file your Form 8606 over the years? Just get the form and its instructions; it'll give you some suggestions on documentation you can use to substantiate your prior after-tax contribution amounts.  If you think the amount of after tax contributions you have forgot to document is significant, then get help form a tax professional so that you don't need to pay tax twice when you take distributions.

32 thoughts on “What’s Not Taxable of Your IRA and 401(k) Distributions?

  1. Since the ira makes you keep track i like the roth best. No need to fill out any forms it is all tax free. I even plan to transfer rest of my regular iras out this year because they have droped in price and swith the stocks over to a roth.

    Best etf funds lits last blog post..Oil etf.

  2. Thanks for the information. My 401k and taxes has always confused me. I barely have the ability to keep up with the basic math related to my apartments, let alone the complex tax issues related to the rentals and my retirement.

  3. Amanda says:

    Definitely good advice for working out the minimal impact of the change of age. It is not always easy to start to do complete the Form 8606 if you haven't done it previously so the advice to use a professional, especially for large amounts of documentation, is really important.

  4. The Tax Club says:

    @ Best etf funds lit: It is subjective whether you opt for IRA or roth. Not everyone would choose roth over IRA irrespective of prices. And you never know who saves what by selecting which option. The most advisable thing is to consult a tax professional who can help strategize your complete tax filing in a way that helps you save more.

  5. Medical Assistant says:

    Interesting article, I can see why the 401k are eating me up a little bit, but i cant really decide what to invest that money into other then my 401k any help?

  6. Bobby says:

    This is just another arguement for reinvesting a 401k. Definately having a tax professional help with sorting out what you wil be taxed on and what you won't is good advice.

  7. Rent [email protected] Finding says:

    True of a regular 401k and IRA, but do not forget that Roth IRAs and 401ks work the opposite way, you pay taxes up front but you do not pay a cent when you take the money out!

  8. How about CD's? or maybe even mutual funds? The stock market can be scary nowadays but it seems like now is the time to buy!

  9. Metal ETFs says:

    Good overview of the tax implications of an IRA distribution. Personally I'm a big fan of the roth. If you are young this is especially true for there being more advantages for investing in a roth. This is because you will be in a higher income bracket once you are older (ideally.) This makes it better to be taxed when you are young in your career rather than at the end.

  10. Martin Star says:

    I understand from a letter I received from the IRS that for this year (tax year 2009) I am not required to make any distribution of my IRA.

  11. Free Software Update says:

    Interesting article, I can see why the 401k are eating me up a little bit, but i cant really decide what to invest that money into other then my 401k any help?

  12. Dump trucks says:

    Very interesting advise, In IRA and 401(k) we can enjoy one more benefit that is no tax is withheld and the employee avoids current income tax on the rollover distribution. Additionally, a traditional IRA may offer more investment options versus a limited 401(k) menu of mutual funds.

  13. I agree with the two posters above....the roth might be the best way to go.

    I'm still fairly young....early forties, so allowing for a higher income by the time I reach my sixties, the tax savings could be quite high.

    Interesting advice, though.

  14. It is a very cruicial advice for me as a businessman, In IRA and 401(k) we are able to get more benefits which are no tax is withheld and the worker avoids current revenue tax at the rollover distribution. And, a traditional IRA maigh offer many investment alternatives versus a limited 401(k) menu of mutual funds. Now I can understant how it available for me. Thank you for your support.

  15. Totem Symbols says:

    Thank you so much for this advice. We are trying to get my father-in-laws finances in order, and knowing that we don't have to worry about this for his 401k is a big relief!

  16. Sim Only says:

    Interesting article, I can see why the 401k are eating me up a little bit, but i cant really decide what to invest that money into other then my 401k any help?

  17. Finances says:

    Should probably specifically mention ROTH 401k's, where the employee specifically makes their tax payment up front, so that there's no withdrawal taxes down the road.

    Of course, the downside is a smaller amount of capital to grow in the 401k. There's no free lunch 🙂

  18. Dental Jobs says:

    Great post. Don't fully understand the 401k distributions, so this was a great post and very information. Thanks

  19. Hayley says:

    Thanks for this great information on 401k. I'll be sure to keep that in mind.

  20. Eugene says:

    Thx for this article. It helped me a lot. Now I understand something about 401k.

  21. Tax Return Sydney says:

    Great to know about 401k and taxes has always confused me. It is a good advice and thank you for this posting.

  22. Sydney Accounting says:

    Great article indead there are so may people who misunderstand the tax law and this will shed some light.

  23. coach outler store online says:

    If you think the amount of after tax contributions you have forgot to document is significant, then get help form a tax professional so that you don’t need to pay tax twice when you take distributions.

  24. Thanks for the info... I was wondering if I can take a tax deduction for my 401k Contribution on my tax return? I am guessing I can't since it has not been included in the taxable income...

  25. Diane says:

    What’s Not Taxable of your IRA and 401(k) Distributions? Thanks for shedding some light on this subject. It can be quite confusing at times but you did clarify what I needed to know. Thanks for the post. Cheap Edmonton Hotels

  26. New tax laws are allowing people who do not qualify for ROTH-IRAs to convert their Traditional or even SEP-IRAs into Roth IRAs and pay the tax now. This is huge for those who aren;t allowed to take advantage of the tax-free growth of an ROTH-IRA. If you have a traditional or SEP-IRA, I'd highly recommend talking to your tax advisor or accountant before the IRS no longer allows this.

  27. John Kohl says:

    Great resource, taxable and non-taxable funds is very confusing to most individuals and this article articulates the differences very well. There is a web tv show on financial retirement planning called Checks and Balances TV that has some good info as well at http://checksandbalances.tv for those that are interested.

  28. Emily Ann says:

    I was not aware that taxes on 401k were this complicated. I appreciate your insight. Hope at some point we can get a tax law simplified and more evenly distributed.

  29. K2 Skier says:

    Great info. I hope I can manage my IRA and 401(K) well so I can spend the rest of my days skiing - on K2 Skis of course!

  30. Taxable and non-taxable funds is very confusing to most individuals. Thanks for the information on 401(k) distributions.

  31. tax credits calculator says:

    it is very important to me as a businessman is advised (k) tax benefits of avoiding the income tax to get a removable rollover distribution of our current staff can not control. In addition, investment funds investment options (k) of the limited number of 401 Maigh a traditional IRA to move into the menu. Now, what I can under the operator. Thank you, thank you for your support.

  32. Confused retireree says:

    When calculating the non-taxable portion of one's IRA distribution, on what date is the total value of one's IRA determined? December 31 of the previous year as for the taxable portion,or on the day the distribution is made? At first, Vanguard tried to divide my total after tax contributions by some number, supposedly the expected number of years I will live times four, and use that amount. It was very small, compared to the amount calculated using the life expectancy tables.

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