Non-deductible contributions to a Traditional IRA come back to you partly tax-free and partly taxable when you withdraw. The after-tax money you put in (your “basis”) was already taxed once, so the IRS does not tax it again. The earnings those contributions produced have never been taxed, so they come out as ordinary income. What you cannot do is take the tax-free portion first. Every distribution is split between taxable and non-taxable dollars using a formula called the pro-rata rule, applied across all of your Traditional, SEP, SIMPLE, and rollover IRAs combined.
What Counts as Basis
Your basis is the running total of every non-deductible contribution you have ever made to a Traditional IRA. It is the money the IRS has already collected tax on. Everything else inside your Traditional, SEP, SIMPLE, and rollover IRAs is pre-tax: deductible contributions you made, pre-tax dollars you rolled over from a 401(k) or similar plan, and all of the growth, dividends, interest, and appreciation on both the pre-tax and after-tax money.
When you withdraw, the basis portion is tax-free. The rest is taxed as ordinary income at your regular rate. If you are under 59½, that taxable portion is also subject to a 10% early withdrawal penalty unless you qualify for an exception.1Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
The Pro-Rata Rule and a Worked Example
You do not get to designate which dollars leave the account. The IRS treats every distribution as a proportional slice of the whole. The share that comes out tax-free equals the share of your total IRA value that your basis represents.
The formula is:
Non-Taxable Portion = (Total Basis ÷ Total Value of All Non-Roth IRAs) × Amount Withdrawn
The “total value” is the balance of all your non-Roth IRAs on December 31 of the distribution year, plus any amounts you took out during the year and any outstanding rollovers.
Say your basis is $20,000 and your combined IRA accounts are worth $250,000 at year-end. Your basis is 8% of the total. If you withdraw $10,000, then 8% of that withdrawal, or $800, is tax-free. The other $9,200 is taxable income. Your remaining basis drops to $19,200 and carries forward. Each future distribution recovers a little more basis the same way, proportionally, until the basis reaches zero.
Which Accounts the IRS Lumps Together
The calculation does not run account by account. The IRS treats all of your non-Roth IRAs as one pool. That includes:
- Traditional IRAs, including any funded with deductible contributions
- Rollover IRAs holding pre-tax money from a former employer’s plan
- SEP IRAs
- SIMPLE IRAs
These accounts are not pulled into the aggregation:
- Roth IRAs
- Employer plans such as 401(k), 403(b), and 457(b) accounts
- Inherited IRAs, in most cases
- Your spouse’s IRAs; each spouse calculates separately
This matters because a large pre-tax rollover can swamp a small basis. If you have $20,000 of non-deductible contributions sitting in one IRA but also hold a $200,000 pre-tax rollover IRA from a former employer, your basis is only about 9% of the pool. Nearly every dollar you withdraw is taxable, even if the money physically leaves the account that holds your after-tax contributions. The pro-rata rule looks past the account and at the total.
You Need Form 8606 to Prove the Tax-Free Portion
IRS Form 8606, Nondeductible IRAs, is the only official record of your basis.2Internal Revenue Service. About Form 8606, Nondeductible IRAs You are required to file it for every year you make a non-deductible contribution (even if you otherwise would not file a return), for every year you take a distribution from a Traditional IRA with existing basis, and for every year you convert Traditional IRA funds to a Roth.3Internal Revenue Service. Instructions for Form 8606
The form keeps a running total. Each year you add new non-deductible contributions to the basis carried over from prior years. When you take a distribution, Part I of the form walks you through the pro-rata math and reduces your basis by whatever portion you recovered.
If you have never filed Form 8606, you have a problem. Without it, you have no documented proof that any of your contributions were after-tax, and the IRS can treat the entire balance as pre-tax money. Every dollar you withdraw then becomes fully taxable. Keep every Form 8606 you have ever filed, along with the Form 5498 statements your custodian sends each year confirming contributions.
If you made non-deductible contributions in past years and never filed the form, you can still fix it. The cleaner approach is to file an amended return on Form 1040-X for each missed year with Form 8606 attached. The amended-return route creates a clearer paper trail if the question ever comes up in an audit.
What Your 1099-R Will Show (and Won’t)
When you take a distribution, your custodian issues Form 1099-R.4Internal Revenue Service. About Form 1099-R Box 1 reports the gross amount withdrawn. Box 2a is supposed to report the taxable amount, but custodians generally cannot calculate it for you because they do not track basis across all your aggregated accounts.5Internal Revenue Service. Instructions for Forms 1099-R and 5498 You will typically see Box 2a either matching Box 1 or left blank with the “Taxable amount not determined” box checked.
You do the actual calculation on Form 8606 and attach it to your Form 1040. Part I takes your running basis, the year-end fair market value of all your non-Roth IRAs, and the amount distributed, then applies the pro-rata formula. The non-taxable portion comes out at the bottom. You subtract it from the gross distribution to get the figure that goes on the IRA distributions line of your 1040. Skip the Form 8606 and the IRS will assume the full amount on your 1099-R is taxable.
Early Withdrawals Before 59½
Age does not change the pro-rata split. It changes the penalty. If you withdraw before 59½, the taxable share of the distribution faces an additional 10% early withdrawal penalty on top of ordinary income tax, unless an exception applies.1Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions The basis portion is not subject to the penalty because it is not taxable to begin with.
Required Minimum Distributions
Once required minimum distributions begin, the pro-rata rule still runs on every withdrawal. You cannot direct your custodian to send out basis first and leave the pre-tax money behind. Each RMD is split in the same proportion as any other distribution.
If your basis is small relative to your total balance, the tax-free share of each RMD will be small. A $20,000 basis against a $500,000 balance means only 4% of each mandatory distribution is tax-free, and the basis trickles back to you across many years of required withdrawals.