Who Pays Taxes on IRA Distributions?
Americans currently hold over $12 trillion in IRAs. Contributions to IRAs are tax deductible and earnings accrue tax deferred until retirement withdrawals take place.
If an account holder dies before taking required minimum distributions (RMDs), their beneficiaries are responsible for meeting those RMD requirements or paying taxes and an additional 10% penalty.
IRA Contributions
Over the past decade, rollover contributions to IRAs have outstripped new contributions – something which bodes well for retirement savings but adversely impacts taxes.
Contributions to traditional IRAs may be tax deductible up to their full value, depending on income; however, this deduction is reduced or eliminated after certain thresholds for those filing separately or jointly who also participate in employer-sponsored retirement plans (please refer to IRS Publication 590-A for further details).
Self-directed IRAs allow investors to invest in assets not normally allowed, including real estate and debt-financed property investments, without incurring taxes as income from these sources is taxed as income in an IRA account.
If you inherit an IRA from someone older than yourself, by April 1 of the year after their death you must begin taking required minimum distributions (RMDs) according to IRS Publication 590-B tables based on life expectancy calculations. Failing to do so incurs penalties in addition to ordinary income taxes.
IRA Earnings
Individual Retirement Accounts provide tax breaks to encourage savings for retirement, yet the government still takes its cut when withdrawing money from an IRA (traditional, SEP or Simple). You will owe tax at ordinary income tax rates when withdrawing funds.
Traditional IRAs allow investment gains to accumulate tax-deferred, with tax being due when withdrawing the funds in retirement. Contributions were taxed at the time they were made; early withdrawal penalties may apply if any distributions are made prior to age 59 1/2.
Your traditional IRA must begin making required minimum distributions – known as RMDs – when you turn 72 or 73, depending on your date of birth. Each RMD must be calculated separately using an IRS table from Publication 590-B; however, you can combine multiple RMDs from one or more accounts to reduce paperwork burden.
IRA Distributions
Contributions to an IRA are tax deductible and earnings accumulate tax deferred until you withdraw funds. Withdrawals prior to age 59 1/2 incur an early withdrawal penalty of 10% in addition to taxes you owe; however, some exceptions exist such as being disabled, purchasing your first home or having high medical expenses that waive that penalty.
Self-employed business owners can increase their savings with a SEP IRA, an alternative retirement savings vehicle which follows similar withdrawal rules but offers greater flexibility for business owners.
If you own an IRA, required minimum distributions (RMDs) must begin by April 1 of the year after reaching age 70 1/2. Heirs to an inherited IRA also need to take RMDs when reaching 70 1/2; these may be taken at any point later on if desired. Cash distributions can be made using check or ACH; alternatively “in-kind” distribution methods allow illiquid assets such as real estate and private placements to be transferred without selling them off first.
IRA Taxes
Individual Retirement Account (IRA) withdrawals are taxed like any other income source; however, contributions to an IRA are tax-deductible while investment earnings build tax-deferred. If you withdraw before reaching age 59 1/2, any distribution will be taxed at your current income tax rate as well as possibly incurring a 10% penalty tax rate.
Once you turn 73, required minimum distributions must begin being taken from your traditional IRA. While you could delay taking your initial RMD until April 1 of the following year if desired, doing so may force you into higher tax brackets.
If you inherit an IRA from someone else, it must first be opened as an “inherited IRA,” and taxed as any traditional IRA would. However, if funds are transferred within 60 days to another traditional IRA within this same calendar year (known as a “rollover”) they won’t incur taxes. Furthermore, only one such “rollover” per calendar year will be accepted.
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