Who Pays Taxes on IRA Distributions?
Although investing in an IRA offers tax breaks, the government still wants its share. They require account holders to make withdrawals within certain time frames and pay taxes upon doing so.
Most individuals must begin taking required minimum distributions by age 72; spouses and some eligible nonspouse beneficiaries can choose to withdraw their money over 10 years, subject to income taxes and penalty charges.
Taxes on RMDs
The IRS distinguishes between withdrawals and distributions from IRAs. Withdrawals occur before age 59 1/2; distributions refer to any amount received from your IRA after that age. Withdrawals typically qualify as ordinary income; however, certain withdrawals such as those made for home purchases or capital expenses do not incur penalties.
A traditional IRA withdrawal’s taxable portion is determined by subtracting its market value from your original contribution, as reported on IRS Form 1099-R and in compliance with federal reporting rules. You should seek more information regarding reporting requirements at their website; additionally, withdrawals may incur a 10% early withdrawal penalty (unless you’re the beneficiary of an inherited IRA, in which case RMDs can be deferred until after death), and prohibited investments like gold bullion must also not be invested in.
Taxes on inherited IRAs
Once an IRA owner dies, his or her assets must be transferred into an “inherited IRA.” This new account cannot be rolled over into an existing one or additional contributions made. Beneficiaries must take required minimum distributions (RMDs) within 10 years after their original account holder’s death.
RMD rules apply to non-spouse beneficiaries as well as heirs who are under 59.5. They must use any money received from an inherited IRA within 10 years unless an eligible designated beneficiary such as their deceased loved one’s spouse or minor children are in place; also eligible designated beneficiaries include trusts for disabled, chronically ill or underage individuals.
If you inherit a substantial sum, seek advice from a tax professional to manage it effectively. Bankrate’s AdvisorMatch service connects you with an IRA inheritance expert who can devise strategies designed to maximize returns while minimizing tax liabilities.
Taxes on rollovers
IRAs can be an excellent way to save for retirement, yet can be complex to administer. For instance, withdrawing money before age 59 1/2 will trigger IRS taxes on any earnings or capital gains included as part of your gross income.
However, there are ways around this penalty. One approach is a rollover, in which assets are transferred directly from one custodian to the next; another option would be direct transfers that involve using electronic or physical transfers to move assets from their current custodian into their new trustee’s hands.
Another option is the 60-day rollover, which enables you to transfer any distribution into an IRA or retirement plan within 60 days. To use this strategy successfully, be sure that any check bearing your name should be made payable directly to the new trustee; otherwise it will be considered taxable income and count towards your annual limit of contributions.
Taxes on direct transfers
The IRS provides a detailed set of rules on how to distribute from an IRA. Their website can serve as an excellent starting point, while your custodian may offer more in-depth guidance or an advisor who specializes in retirement planning may offer more helpful guidance.
Distributions from an IRA are generally taxed as ordinary income; exceptions include distributions made before age 59 1/2 which incur a 10% penalty, home purchases made with money from your IRA, unreimbursed medical expenses exceeding 7.5% of adjusted gross income and payments of health insurance premiums while out of work. However, certain expenses such as payment of health insurance premiums while you’re unemployed could warrant special consideration.
Take careful account when withdrawing funds from an IRA – their impact could be far-reaching on your Social Security benefits! If your combined income, including withdrawals from an IRA, exceeds certain thresholds, up to 85% of your Social Security benefits may become taxable – therefore requiring you to carefully manage how you utilize IRA funds.
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