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How IRA distributions are taxed

Posted by Cheryl Costa  February 9, 2012 09:34 AM

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Generally speaking, if an investor takes a distribution from his or her Individual Retirement Account (IRA), the full amount of withdrawal is taxed at ordinary income tax rates. However, it is important to note that this rule-of-thumb is only true when all of the contributions made to the IRA were deductible. If some of the contributions made to the IRA were not deductible, then the investor has "basis" in the IRA and when the non-deductible amount is later withdrawn, it is not taxable.

If you have made both deductible and non-deductible contributions to an IRA, you may wonder if you can take out only the non-deductible contributions to avoid owing taxes. That is a nifty idea, but it's not possible. In what is often described as the "cream in the coffee rule", a part of each withdrawal is tax free until all of the non-deductible amount is withdrawn.

For more information on how IRA withdrawals are taxes, visit the IRS website and search for Publication 590. If you believe you have made non-deductible contributions to your IRA but are unsure of the amount that was not deductible, look through your tax records for a Form 8606, which tracks the non-deductible contributions.

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