What is the 'Form 8606'
The form 8606 is a tax form distributed by the Internal Revenue Service (IRS) and used by filers who make nondeductible contributions to an IRA. A separate form should be filed for each tax year that nondeductible contributions are made.
Form 8606 is also required whenever: 1) a taxpayer converts a Traditional or SEP IRA into a Roth IRA, or 2) receives an IRA distribution that is attributable to previous nondeductible contributions. If 8606 is not filed in a distribution year, the taxpayer is likely to be forced to pay income taxes (and possibly penalties) on what could be tax-free monies.
BREAKING DOWN 'Form 8606'
Form 8606 should be filed in conjunction with the standard income tax forms (1040, 1040A, or 1040NR) for individual filers. Any taxpayer with a cost basis above zero for IRA assets (a combination of post-tax and pretax contributions, or deductible and nondeductible contributions) should use Form 8606 to prorate the taxable vs. nontaxable distribution amounts.
Younger investors should consider "recharacterizing" Traditional and SEP IRA assets as Roth assets; the tax hit may be outweighed over time by not having to pay taxes on future distributions, which should theoretically have more value due to inflation.