Are nondeductible contributions to a traditional IRA taxable if I withdraw those funds early?

Several years ago I made nondeductible contributions to a traditional IRA after receiving proceeds from a life insurance policy. I needed to withdraw most of the money this year primarily to pay off debt. I am only 57. Since these contributions were nondeductible, do I have to pay tax on the withdrawn funds? I know the withdrawal is subject to a 10 percent penalty.

The early withdrawal penalty only applies to the taxable portion of the early withdrawal (and the penalty is waived for certain types of withdrawals, like full disability, etc.). The amount that you withdraw that was your contribution is not taxable either, as you already paid tax on it – at least to the IRS. State may be different. You must prorate your distribution between contributions and earnings to figure the portion that will be considered tax free and penalty free. As an example, if you put $5,000 into an IRA as a nondeductible contribution, and it is now worth $10,000, divide the $5,000 by $10,000. So, 50 percent of your withdraw would be penalty and tax free, and the remainder would be subject to income tax and the 10 percent penalty.

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Answered by: Colleen S. Krcelich, CPA, is an adjunct professor at Northampton Community College in Bethlehem, Pa.