'For Woodward employees, maintaining accurate retirement records and understanding how after-tax IRA contributions are reported can help reduce avoidable tax reporting mistakes, and Michael Corgiat, a representative of The Retirement Group, a division of Wealth Enhancement Group, encourages individuals to work with qualified tax professionals for personalized tax guidance while making retirement planning part of a well-coordinated long-term financial strategy.' — Michael Corgiat, a representative of The Retirement Group, a division of Wealth Enhancement Group.

'For Woodward employees, understanding the importance of tracking after-tax IRA contributions and maintaining complete records can make retirement planning more effective, and Brent Wolf, a representative of The Retirement Group, a division of Wealth Enhancement Group, encourages individuals to coordinate with qualified tax professionals when addressing tax reporting questions as part of a broader retirement strategy.' — Brent Wolf, a representative of The Retirement Group, a division of Wealth Enhancement Group.

In this article we will discuss:

1. Why after-tax IRA contributions and IRS Form 8606 matter for reducing the possibility of paying unnecessary taxes.

2. How the IRS pro rata rule determines the taxable and tax-free portions of IRA distributions.

3. Key recordkeeping and retirement planning considerations for Woodward employees.

Susan paid income tax on $50,000 that should have been tax-free after an audit of her IRA activity. She believed her IRA custodian would tell her how much of her IRA distribution was nontaxable. She was mistaken. Tracking and accurately reporting after-tax amounts in a traditional IRA is the responsibility of the IRA owner, even though an IRA custodian handles certain administrative tasks. For Woodward employees, understanding these rules can help reduce the likelihood of costly tax reporting mistakes. The following explains Susan's error and the steps she took to correct it.

Why $50,000 Was Tax-Free

In 2024, Susan had $1 million in her traditional IRA. It included:

• - $40,000 in nondeductible (after-tax) traditional IRA contributions.

• - $60,000 in rollovers of after-tax amounts from her 401(k).

• - $900,000 in deductible traditional IRA contributions, pre-tax amounts rolled over from her 401(k), and investment earnings accumulated inside her traditional IRA.

As a result, her IRA consisted of 90% pre-tax money and 10% after-tax money.

Distributions from the pre-tax portion are generally taxable as ordinary income because the $900,000 represented pre-tax contributions and earnings.

The remaining $100,000 represented after-tax money that had already been taxed and therefore was not subject to income tax again when distributed.

In 2024, Susan withdrew $500,000 from her IRA.

The Tax Treatment

Under the IRS pro rata rules for traditional IRA distributions, Susan's $500,000 withdrawal included both pre-tax and after-tax money based on her total IRA basis. Assuming the combined balance of all of her traditional, SEP, and SIMPLE IRAs was $1 million, $450,000 of the distribution was taxable, while $50,000 represented a tax-free return of her after-tax basis. 

However, Susan's tax return reported the entire $500,000 distribution as taxable income.

For Woodward employees with both pre-tax and after-tax retirement assets, understanding how the IRS calculates taxable distributions can help reduce the chance of similar reporting errors.

What Went Wrong

Susan had never filed IRS Form 8606.

Whenever she made nondeductible IRA contributions, she wrote 'nondeductible' in the memo line of her contribution checks. She also provided her IRA custodian with documentation identifying the pre-tax and after-tax portions when she rolled after-tax funds from her 401(k) into her traditional IRA.

Because her former 401(k) administrator had calculated taxable distributions, Susan assumed her IRA custodian would do the same and report the taxable amount on Form 1099-R.

Unfortunately, IRA custodians generally do not calculate the taxable portion of distributions involving after-tax IRA basis and typically do not track an individual's after-tax basis. That responsibility belongs to the IRA owner.

As a result, Susan's IRA custodian reported the full $500,000 distribution on Form 1099-R and checked the box indicating that the taxable amount was not determined.

A Planning Tip

Form 1099-R reports the total IRA distribution in Box 1 (Gross Distribution). When the IRA custodian cannot determine the taxable amount because after-tax basis may exist, Box 2b ('Taxable amount not determined') is commonly checked. This allows the taxpayer to calculate the taxable and nontaxable portions using IRS Form 8606.

Susan, who prepared her taxes as a self-employed investor, assumed the amount shown on Form 1099-R was entirely taxable. She also expected the after-tax portion of her IRA would automatically be recognized as tax-free in future years.

Because her IRA basis was never properly established through IRS Form 8606, those after-tax amounts were not reflected on her tax return.

IRS Form 8606 should be filed:

• - Each year a nondeductible traditional IRA contribution is made.

• - For every IRA distribution that includes after-tax amounts.

• - For any Roth conversion involving after-tax funds.

As Susan's experience demonstrates, failing to file Form 8606 can result in paying income tax on money that has already been taxed.

Correcting the Error

Fortunately, Susan worked with her CPA to resolve the issue. Together they:

• - Retroactively filed IRS Form 8606 for every year she made nondeductible traditional IRA contributions.

• - Filed Form 8606 for 2024 to properly report the taxable and nontaxable portions of her $500,000 IRA distribution.

• - Filed an amended 2024 federal income tax return so the $50,000 after-tax basis would be correctly treated as tax-free.

Filing Reminder

IRS Form 8606 should always be filed for the tax year in which the activity occurred.

For example, if Susan made a $5,000 nondeductible traditional IRA contribution during 2020 but did not file Form 8606 until 2025, her CPA would still complete the 2020 version of Form 8606 to properly report that contribution.

IRA Lessons from Susan's Experience

Track Your Contributions

Traditional IRA contributions may be deductible or nondeductible.

Your tax professional can determine whether your contribution qualifies for a deduction by using the IRA Deduction Worksheet included with IRS Form 1040 instructions. 

If you choose not to deduct the contribution, or you are not eligible to deduct it, the contribution becomes nondeductible and IRS Form 8606 is required to establish your after-tax basis.

Understand IRA Distributions

Traditional IRA distributions are generally taxable as ordinary income.

However, any portion representing after-tax contributions is not taxed again when distributed.

IRS rules require distributions from all of your traditional, SEP, and SIMPLE IRAs to contain both pre-tax and after-tax amounts proportionately. 

Likewise, Roth conversions are treated as IRA distributions for tax purposes, and IRS Form 8606 is required whenever after-tax amounts are involved. 

Maintain Complete Records

Without proper documentation, you could pay taxes twice on the same money.

Keep copies of:

• - Every IRA contribution record.

• - Documentation of rollovers, especially after-tax amounts from employer retirement plans.

• - IRS Form 5498 showing IRA contributions. 

• - IRS Form 1099-R reporting IRA distributions. 

• - Your federal income tax returns.

If you are unsure whether your IRA includes after-tax basis, ask your CPA to review your IRA history using these records to identify any reporting errors or missed tax opportunities.

For Woodward employees, maintaining organized retirement records can make it easier to coordinate IRA planning with workplace retirement benefits throughout your career and into retirement.

Looking Ahead

If Susan expects future traditional IRA contributions to be nondeductible, she may want to consider contributing to a Roth IRA if she qualifies. If she exceeds the income limits for direct Roth IRA contributions, she should discuss with her tax advisor whether a backdoor Roth IRA strategy may be appropriate based on her individual circumstances. 

Retirement Planning for Woodward Employees

Understanding IRA basis, distributions, Roth conversions, and IRS reporting requirements can be complicated. For Woodward employees, these decisions are often one part of a broader retirement strategy that may also include employer-sponsored retirement benefits and long-term income planning.

The Retirement Group helps Woodward employees evaluate retirement decisions and understand how IRA planning fits into their overall retirement strategy. If you have questions about your retirement options or would like information tailored to your situation, call The Retirement Group at (800) 900-5867 to learn more.

Sources:

1. Internal Revenue Service.  Instructions for Form 8606: Nondeductible IRAs . U.S. Department of the Treasury, 2025,  https://www.irs.gov/instructions/i8606 . Accessed 30 June 2026.

2. Internal Revenue Service.  Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs) . U.S. Department of the Treasury, 2025,  https://www.irs.gov/publications/p590a . Accessed 30 June 2026.

3. Internal Revenue Service.  Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs) . U.S. Department of the Treasury, 2025,  https://www.irs.gov/publications/p590b . Accessed 30 June 2026.

4. Internal Revenue Service.  Instructions for Forms 1099-R and 5498 . U.S. Department of the Treasury, 2025,  https://www.irs.gov/instructions/i1099r . Accessed 30 June 2026.

5. FINRA.  Traditional IRA . Financial Industry Regulatory Authority,  https://www.finra.org/investors/investing/investment-accounts/retirement/traditional-ira . Accessed 30 June 2026.