Understanding what the IRA basis is should be simple, given how basic the concept around it is. However, most of what’s written about it is just definitions and extracts from the circulars, making it a little difficult for everyone to understand. So, here’s my simplistic take on teaching you everything you need to know about the IRA basis.

What is IRA Basis?

IRA basis is the sum in your IRA that has already been taxed once. This can be in the form of non-deductible IRA contributions or contributions made from after-tax dollars. 

Think of it this way. You have earned certain income and have already paid tax on it. Now you contribute it in an IRA, and for some reason are required to withdraw the contributed amount three years later. Should you be taxed on the withdrawal again? Obviously not. This is where the concept of an IRA basis comes into the picture. It is that portion of your contribution which will not attract any tax liability when withdrawn because you have made the same through post-tax dollars (or haven’t claimed the same as a deductible towards annual income). The whole idea behind an IRA basis is to avoid double taxation on your hard-earned money.

Types of IRAs:

The first decision that investors must make when deciding on individual retirement savings is figuring out which type of individual retirement account is best for them. They mainly have two options: Traditional or Roth. Both are tax-advantaged accounts but how they are tax-advantaged varies. 

Traditional IRAs are tax-advantaged on the front end. Money invested into a Traditional IRA reduces taxable income which makes the funds technically “not taxed.” Uncle Sam wants his cut sometime though, so money invested in a Traditional IRA is taxed on the back end when the money is taken out of the account. Roth IRAs, on the other hand, are the opposite of Traditional IRAs, as the money invested in them is after-tax dollars. 

Traditional IRA contributions reduce your taxable income while Roth IRA contributions do not. However, because the money invested in a Roth has already been taxed, Roth IRA participants can pull money out of their IRA without tax consequences in retirement.

And for the decision, traditional IRAs are best for people who need to reduce their taxable income now and anticipate that they will be in a lower-earning tax bracket later. Roth IRAs are best for people who want a more see what you get approach in their retirement dollars and don’t want to have to worry about tax implications later on.

Tracking Your IRA Basis:

IRS basis must be kept track of or tax-free withdrawals can quickly become a taxable event. Both Traditional IRAs and Roth IRAs have an IRA basis that must be tracked through the IRS Form 8606. For Roth IRAs, the IRA basis is the sum of all contributions made to the account, while the same for Traditional IRAs is limited to the sum of non-deductible contributions or contributions made using after-tax dollars. For example, non-deductible contributions can result from a rollover from another qualified account involved like a SIMPLE or SEP.

Form 8606 is also used when converting a traditional IRA to a Roth IRA. Taxes must be paid when the conversion happens and, thus, all the money in the new Roth IRA is considered an IRA basis for taxation purposes later.

However, the IRA basis only matters for withdrawals made “early” or before the age of 59 ½. Such withdrawals are subject to a 10% early distribution penalty and they may be subject to taxation on the outgoing side too if there is not an accurate Form 8606 keeping track of the after-tax money invested.

With that being said and before we move on, let me reiterate on this one important point yet again: Investors and/or their tax professionals are responsible for keeping track of the IRA basis.

Best IRAs:

Now that we know a little more about Roth and Traditional IRAs, how do we pick which IRAs are best to help us meet our goals? The Roth or Traditional IRA question can be answered by whether or not an investor needs a reduced tax liability today (use a Traditional IRA) or would prefer no taxes on retirement dollars (use Roth IRA). Once that is decided, investors, can make decisions about what assets to choose inside their IRA.

There are some universal principles of investing that every investor should take into consideration when making decisions about their future. Investors first want to identify their risk tolerance and what goals they have for their investing. Once those two things are decided and investors are ready to proceed, they need to make sure that their accounts are properly diversified. No investor should have all of their money in one asset or eggs in one basket.

There are lots of ways to diversify a portfolio, but generally speaking, investors want to have several different assets in their portfolio that are all going to react in different ways to the same market event. It is a way of grounding your portfolio while also taking advantage of any potential growth.

A great grounding asset for portfolios is investing in precious metals- more specifically, gold and silver. Gold and silver are considered hedges to inflation because despite what paper currency is doing, gold and silver will always be a store of value and are impervious to political and economic uncertainty. Further, precious metals are highly liquid but also scarce enough to ensure that the supply and demand scales are generally in the investor’s favor. And unlike dollars, governments can’t print more gold bars.

Gold and Silver IRAs:

Investors looking to add gold and/or silver into their retirement investment portfolio will need to find a self-directed IRA. These IRAs allow investors to participate in gold and silver using a custodian who will physically hold the gold and silver for the investor, so they don’t have to try and figure out how to store physical metals. The responsibility for finding a reliable custodian falls on the investor, but there are plenty of custodians out there who have a preferred relationship with hundreds of brokers and they can be a good starting point for your search.

Self-directed IRAs are available in both Traditional or Roth – the same rules for which one is best still apply – and they simply allow investors to hold a variety of investments that cannot be held in standard Traditional or Roth IRAs.

Once investors have settled on which custodian to use and which metals, they can fund their IRA and purchase gold and silver inside of it, thereby ensuring that at least a portion of their retirement investment is in an asset that will protect them from inflation. An important point to note is that gold and silver IRAs do typically have slightly higher fees but that is because storing and protecting actual metals is an expensive endeavor.

Final Thoughts:

An IRA basis is the sum you can withdraw from your individual retirement arrangement account tax-free. You are likely to be denied a tax break on your basis if you haven’t kept a record of the same and hence, ensuring that your IRS basis is accurately tracked through a meticulously filed Form 8606 is essential. 

As for ensuring that your IRA assets are helping you meet your goals, try to strike a balance between growing and protecting. The balance between the two can seem tedious, but adding gold and/or silver to your portfolio can certainly offer a solid foundation of protection

Despite which type of individual retirement account is best for you- Traditional or Roth, there are some important things to consider like ensuring that your IRS basis is accurately tracked and that the investment assets you choose are moving you closer to your goals while protecting your portfolio at the same time.

Always remember that you are responsible for keeping track of IRA basis or your after-tax/non-tax-deductible IRA Contributions year after year. Saving this information will keep you from being double-tapped by Uncle Sam in the event of an early distribution situation.

As for ensuring that your IRA assets are helping you meet your goals, try to strike a balance between growing and protecting. The balance between the two can seem tedious, but adding gold and/or silver to your portfolio can certainly offer a solid foundation of protection.

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I hope you found this short post about IRA basis to be helpful and that you now have a better understanding on what it is. Please share your own experience on this subject in the comment section below as it can help others make better decisions! Also, if you got any questions about this I would be more than happy to answer them below!

I wish you success!

Meagan, financial advisor and a team member of Gold Retired

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FAQs

What does IRA stand for?

IRA stands for Individual Retirement Arrangement (also known as Individual Retirement Accounts). 

How to calculate IRA basis?

For Roth IRAs, the basis is equal to all contributions made to the account. On the other hand, for traditional IRAs, only the sum of non-deductible contributions is to be taken for calculating the IRA basis. This is because many of the contributions made to a traditional IRA account are tax-deductible in the year that they are contributed.

Does IRS keep a track of my IRA basis?

No, the IRS generally does not keep a track of your IRA basis. It is your responsibility to track and file the IRA basis each year through Part I of the Form 8606.

What is the penalty for not filing Form 8606?

Failing to file Form 8606 when applicable can attract a penalty of $50 while overstating the non-deductible contributions can attract a penalty of $100.

Does total basis decrease when withdrawals are made?

Yes, when you make a withdrawal, the total basis does decrease. The taxable and non-taxable portions of the withdrawal are determined by the proportion of after-tax funds (basis) to the total balance of the IRA. This is calculated using the IRS Form 8606.