If your traditional IRA holds a mixture of deductible (after-tax) and nondeductible (pretax) contributions, it’s important to track your contributions to avoid double taxation of distributions. Why? Because the IRS treats distributions as a blend of pretax and after-tax dollars. If you treat distributions as fully taxable, you’ll end up overpaying. One way to track and report your deductible and nondeductible IRA contributions is to complete and file Form 8606, “Nondeductible IRAs,” with your federal income tax return each year. If you have several IRAs, you can’t avoid tax by taking distributions from those accounts. All your traditional IRAs are treated as a single IRA for tax purposes.
When moving your retirement money to an IRA, you should follow this one rule of thumb. If you fail to follow the rule I’m about to reveal, you can face two big problems:
- First, your check will be shorted by 20 percent.
- Second, you will be on the search for replacement money.
Here is this significant rule of thumb that you need to follow: Move the money using a trustee-to-trustee transfer. Nothing else. There are two types of transfers that can be used to move qualified plan distributions into IRAs in a tax-free manner: (1) direct (trustee-to-trustee) rollovers and (2) what we will call traditional rollovers.
If you want to do a tax-free rollover, do nothing other than the direct (trustee-to-trustee) rollover of your qualified retirement plan distribution into the rollover IRA. This is easy to do.
Just instruct the qualified plan trustee or administrator to (1) make a wire transfer into your rollover IRA or (2) cut a check payable to the trustee of your rollover IRA (this option is not as preferable than a wire transfer). Your employee benefits department should have all the forms necessary to arrange for a direct rollover.