section 1 - The American College Online Learning Center

(2) Under this rule, the distribution is taxable income; however, the deathbeneficiary is eligible for a deduction for estate taxes paid.(3) Example: A $1 million IRA is distributed to a death beneficiary. In thiscase, the decedent’s estate paid $300,000 of estate taxes. The beneficiaryis entitled to a deduction of $300,000 and only pays income taxes on$700,000.(4) Deduction is pro rata for partial distributions.e. Pre-59½ withdrawals are subject to a 10% penalty unless an exception applies.5. Cost recovery of amounts that were already taxeda. Types of cost basis(1) After-tax contributions in a qualified plan (only common today in largecompany 401(k) plans)(2) Nondeductible contributions to IRA(3) Table 2001 amounts that are subject to income tax each year because theplan includes a life insurance policy on the life of the participantb. Cost recovery methods(1) Clients may be able to roll over all of the distribution to anothertax-advantaged plan except for the cost basis. When this is the case, therewill be no tax consequences. This is an effective way to get the after-taxamount outside of the plan without paying taxes.(a) Example: A client takes a distribution from a qualified plan of$100,000 that includes $10,000 of after-tax contributions. She rolls$90,000 into an IRA. The $10,000 withheld is considered the costbasis and there are no tax consequences.(2) Withdrawals prior to retirement to a client that has after-tax contributionsin a qualified plan are taxed on a prorated basis—but only looking at theafter-tax account.(a) Example: A client has $200,000 in a 401(k) plan and has anafter-tax account with $20,000. Only $10,000 is from contributionsand $10,000 is earnings. If prior to retirement the client withdraws$10,000 from the after-tax account, $5,000 is taxed and $5,000 istax-free. This is determined by multiplying the $10,000 withdrawalby a fraction; $10,000 (the cost basis) divided by $20,000 (thevalue of the after-tax account).(3) Annuity payments from qualified plans are subject to a special recoveryrule. This is not a very common situation since there are so few after-taxcontributions in tax-advantaged plans.(4) The IRA cost recovery method is the most common situation that will occuras some clients will make nondeductible IRA contributions(a) To determine how much of each distribution is recovered tax free,use a prorated recovery method based on ratio of nontaxableamounts to value of all IRAs.(b) Example: Client has an IRA worth $50,000 with $20,000 ofnondeductible contributions. The client withdraws $10,000. If thisis the client’s only IRA, the portion that is not taxed is $10,0004.7