How Much Tax Do I Pay on an IRA Withdrawal After Retirement?
Withdrawals from retirement accounts generally count as ordinary income, subject to certain exceptions such as unreimbursed medical expenses or first-time home purchases. Furthermore, any portion that represents previously tax-deductible contributions and earnings will incur an additional 10% penalty tax.
Custodians typically withhold taxes from your withdrawals from an IRA account, just as employers withhold from paychecks. You can use IRS Publication 590-B to determine your required minimum distributions (RMDs).
Taxes
Your withdrawals from an IRA and any tax-deferred accounts you own – including 401(k)s and 403(b)s – must pay income taxes, which reduce the amount available for spending.
Savers may incur a 10% early withdrawal penalty on traditional IRAs made before age 59 1/2, in addition to paying ordinary income taxes on amounts that represent previously deductible contributions and earnings. There may be exceptions available.
To give an example, you can withdraw up to $10,000 tax-free when buying your first home or paying qualified higher education expenses for yourself or family members. New parents can withdraw up to $5,000 tax-free per year in child care and preschool costs without incurring penalties.
Once you reach the required minimum distribution (RMD) age — currently set at 72 for those turning 72 by 2023 — it is mandatory that annual withdrawals from traditional, SEP and SIMPLE IRAs begin. RMDs are calculated using life expectancy factors determined by the IRS and require at least some portion of total account value be distributed each year as RMD withdrawals.
Penalties
Withdrawals from an IRA may incur penalties in certain circumstances. For instance, withdrawing funds prior to turning age 59 1/2 generally incurs a 10% penalty tax plus income taxes on what was taken out.
Purchasing your first home? Penalty-free withdrawals may be made from either a traditional or Roth IRA to cover its purchase; however, any such withdrawal must not exceed $10,000.
Once you reach the age of 70.5, required minimum distributions (RMDs) from your IRAs should begin automatically. Your RMD is calculated based on life expectancy and balance at end-of-year balance in your account; IRS has provided a table to help calculate RMDs; however, for optimal results please seek advice from an advisor as there may be specific rules applicable in your situation.
Exceptions
If you withdraw funds for certain exceptions, such as unreimbursed medical expenses exceeding 7.5% of adjusted gross income reported during the year in which you take out money from an IRA account, there won’t be a 10% penalty attached to this withdrawal. These expenses must have occurred during that specific year of withdrawal to qualify as allowable expenses.
Your IRA distribution can also be used without incurring penalties to purchase your first home if it meets IRS criteria and within 120 days of taking out a distribution. Furthermore, this rule also allows for using distributions to pay higher education expenses of yourself, spouse or children and satisfy an IRS levy or health insurance premiums during unemployment.
Failure to take your RMDs by their due date will incur a 25 percent penalty, so to prevent this scenario, use the IRS Uniform Lifetime Table annually as a way of identifying your required distribution and planning ahead accordingly.
Planning
Your payment depends on the type of IRA, age and purpose of withdrawal. You can lower your tax bill by taking smaller withdrawals or withdrawing funds from Roth IRAs which don’t incur income tax liabilities.
Custodians typically withhold 10 percent of withdrawals for federal taxes unless you opt out or reduce that withholding amount. You should consult the IRS Uniform Lifetime Table each year to calculate your Required Minimum Distribution (RMD), which depends on your age, life expectancy and account balance as of Dec 31 of the prior year.
Your best way to avoid penalties when taking Required Minimum Distributions is coordinating them with other sources of taxable income and spreading withdrawals throughout the year. Furthermore, be mindful of penalty-free IRA withdrawal rules: these include unreimbursed medical expenses exceeding 7.5% of adjusted gross income, health insurance premiums while unemployed or first time home purchases as examples.
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