The taxes on withdrawals from an Individual Retirement Account (IRA) depend on your deductions and income.
Taxes on Roth IRA Accounts vs. Traditional IRA Accounts
The same rules do not apply to Roth IRA accounts. Roth accounts are a completely different type of retirement account. Contributions to a traditional IRA are made with pre-tax dollars. In contrast, contributions to Roth IRA accounts are made with after-tax dollars, which is an important distinction. You have already paid income tax on this income in the year you earned it. You can therefore withdraw money from a Roth IRA without paying taxes.
How to Report Distributions from Your Traditional IRA
The total amount of taxes you will pay on your annual distributions from a traditional IRA depends on your total income and the deductions you can claim for that year.
Tax Treatment of Traditional IRA Distributions
Add your traditional IRA distributions to your other sources of income to determine your adjusted gross income (AGI) for the year. Your AGI is reduced by allowable deductions, resulting in taxable income. You can expect to pay more taxes on your IRA distributions compared to someone with lower income and more deductions if you have high income and can claim very few deductions.
Early Withdrawal Penalties
The penalty as of 2021 is 10% if you withdraw money before reaching the age of 59 and a half. You must pay that plus income tax unless you qualify for an exception.
Required Minimum Distributions
You cannot take distributions early, and you also cannot leave your IRA account untouched forever while it grows and accumulates. You must begin taking required minimum distributions (RMDs) if you reach the age of 70 and a half in 2019 or earlier. You must start taking RMDs by April 1 following the year you turn 72 if you reach age 70 and a half in 2020 or later.
What Happens If You Move Money from a 401(k) Account?
You can move money from a 401(k) account to an IRA through a process called “transfer.” The money is not taxable when moved from a 401(k) plan because it is moving from one qualified tax-deferred retirement account to another.
Example of Traditional IRA Distribution Tax
Let’s assume you are single and 65 years old in 2022. You need to withdraw from your IRA to cover your living expenses. You need to take $2,500 monthly, or $30,000 annually, to meet your needs.
You will have $12,000 of retirement income in addition to this $30,000. Therefore, you will have an adjusted income of $42,000 for the year, assuming you cannot claim any income deductions to reduce that amount.
The first $10,275 of income is taxed at 10% for a single filer in 2022. The taxable income from $10,276 to $41,775 ($31,725) is taxed at 12%. You will therefore pay $4,834.50 in taxes: $1,027.50 on the first $10,275 of income, plus $3,807 on the other income of $31,725.
Frequently Asked Questions (FAQs)
When do you pay taxes on IRA withdrawals? You can either have taxes withheld from your distributions or settle your tax liability when you file your tax return. Using the previous example, you may have paid enough taxes throughout the year to cover your estimated tax liability of $4,834.50 if you had any taxes withheld from your IRA and your retirement distributions. You must pay taxes to the IRS by tax day (usually April 15) if you do not withhold that amount.
What
What is the minimum required percentage for your IRA distribution to meet the required minimum? You don’t need to worry about the required minimum distributions if you have a Roth IRA, unless you inherited it. The percentage gradually increases from about 3.6% at age 70 to over 50% (at age 115) for traditional IRA accounts. You can use a worksheet from the IRS to determine your percentage.
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Sources:
Internal Revenue Service. “Publication 590-B (2020), Distributions from Individual Retirement Arrangements (IRAs).”
Internal Revenue Service. “Questions and Answers About the 2018 Form 1040.”
Internal Revenue Service. “Retirement Topics – Exceptions to Tax on Early Distributions.”
Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs.”
Internal Revenue Service. “Rollovers of Retirement Plan and IRA Distributions.”
Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”
Source: https://www.thebalancemoney.com/how-taxes-on-normal-ira-distributions-work-2388978
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