Taxes on an IRA After Retirement
An Individual Retirement Account, or IRA, allows you to set aside funds without incurring taxes until withdrawing them in retirement – typically at a lower tax rate than at higher earnings levels.
Many life events can place you into a higher tax bracket, such as inheriting money or selling property, but with proper planning you can avoid these surprises and stay within the law.
Taxes on IRA withdrawals
As a general rule, any distributions from an IRA are taxed like income would be on your paycheck. This applies to Traditional, SEP and SIMPLE IRAs alike. In certain circumstances however, retirement account withdrawals may be partially tax-free, such as when nondeductible contributions or rolling over after-tax funds from employer plans into Traditional IRAs were made.
IRA distributions made before reaching age 59 1/2 incur an early withdrawal penalty of 10% in addition to ordinary income taxes, with certain exceptions such as using funds for qualifying education expenses or purchasing your first home without incurring this tax penalty. You may also withdraw money without penalty in an emergency medical situation or when being called up as part of the military reserve force.
As soon as an individual turns age 73*, the IRS mandates that annual minimum distributions (RMDs) begin being taken from your Traditional, SEP or SIMPLE IRA accounts. Your RMDs can be calculated by dividing the total balance of each IRA by your life expectancy; you can find this in IRS Publication 590-B life expectancy tables.
Taxes on IRA distributions
If you own a traditional retirement account, RMDs must begin on April 1 of the year after turning 70; for newer retirees this threshold was recently increased to 72 as per the Setting Every Community Up for Retirement Enhancement Act of 2023. You may choose to spread out the tax bill over multiple years by making smaller withdrawals at different intervals.
Distributions from an IRA are taxed as ordinary income, so the exact amount owing will depend on both your overall income and deductions that year, as well as any basis information held. It’s important to keep track of this data to avoid double taxation or understating basis – those leaving their IRA to beneficiaries must also leave them a form that displays it.
Nonqualified IRA distributions are subject to taxes and an early withdrawal penalty of 10%; exceptions exist for medical expenses and purchasing your first home. IRS Form 5329 should be filed along with your tax return in order to pay or claim an exception to the penalty; these distributions are then added to your adjusted gross income (AGI); higher AGI amounts result in more tax liability while lower AGI allows greater deductions.
Taxes on IRA rollovers
IRA rollovers allow you to transfer money directly from an employer retirement plan into an IRA account, providing greater control and choice in investments than what may be available through their plan provider. They may be useful if your current plan does not provide your preferred options or should it do, it could provide another means of switching providers – another advantage being portability of investments if needed.
Rollover rules for an IRA are simple. Your old employer plan may send the distribution directly into your new IRA; or an indirect rollover could occur by having the old employer send a check that you deposit into it yourself later. Either way, this must take place within 60 days otherwise any distributions would be considered taxable and you could incur an early withdrawal penalty of 10% if under age 59 1/2.
Ideally, when opting for direct rollover, notify the administrator of your old retirement plan that you would like the funds sent directly into an IRA. This way, no income taxes are withheld, as well as to reduce potential mistakes. Alternatively, hire a financial advisor or select an automated robo-advisor which uses computer algorithms to select and rebalance investments at much reduced costs than their human counterparts.
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