Distributions of funds from a retirement plan are subject to federal and international income tax withholding. The federal income tax withholding rate depends on two factors:
Types of Retirement Plan Distributions
There are several different types of distributions from retirement plans.
Regular Distributions
Regular distributions occur when money is withdrawn from the retirement plan after reaching retirement age.
Required Minimum Distributions
Distributions that must occur from tax-deferred retirement plans, such as a traditional Individual Retirement Account (IRA), 401(k), or 403(b), once you reach age 72, are known as required minimum distributions (RMDs).
Periodic Distributions
Periodic distributions are retirement or annuity payments made regularly (weekly, monthly, or annually) to the employee and/or beneficiaries for more than one year.
Non-Periodic Distributions
One-time payments from the retirement plan to the employee are known as non-periodic distributions. Non-periodic distributions do not include IRA transfers or rollovers, regular withdrawals, or required minimum distributions (RMDs).
Tax Withholding on Periodic Distributions
Periodic distributions are subject to tax withholding using the same wage income methods. You will need to complete Form W-4P to inform the retirement plan administrator of your tax exemptions. This applies to payments received from:
- A pension plan, or retirement, or profit-sharing plan, or stock bonus plan from your employer
- Traditional IRA
- Any other deferred compensation plan
- Commercial annuity purchased from an insurance company
You may also choose not to withhold any federal tax on periodic distributions by writing “no tax withholding” in the space below Step 4(c) on Form W-4P. You will only need to complete Sections 1 and 5. If you choose not to withhold any tax, you may have to pay estimated taxes.
Tax Withholding on Non-Periodic Distributions
You do not need to show hardship to take a distribution from an IRA or retirement annuity before age 59 and a half. When doing so, these non-periodic distributions will be considered part of your taxable income.
These distributions are subject to federal income tax withholding at a flat rate of 10%. You may also request additional withholding on your Form W-4R.
If you receive a qualified rollover distribution that is not a rollover, the withholding tax will be at a rate of 20%. However, no tax will be withheld if it is rolled over directly to an IRA or another qualified retirement plan.
If you take a distribution from a SIMPLE IRA in the first two years of participation in the plan, it will be subject to an additional 25% tax.
Non-Periodic Distributions from an Employer Retirement Plan
Non-periodic distributions from an employer retirement plan, such as 401(k) or 403(b) plans, are subject to federal income tax withholding at a flat rate of 20%. Non-periodic distributions from an employer plan include lump-sum distributions, even if those distributions are later rolled into another plan.
However, if the distribution is rolled directly into another retirement plan in a direct transfer from custodian to custodian, no withholding tax is required.
If you receive the distribution before reaching age 59 and a half, it may be subject to an additional 10% tax penalty for early distributions.
Tax Withholding on Social Security Benefits
You can choose to have federal income tax withheld from your Social Security benefits. Federal income tax can be withheld at rates of 7%, 10%, 12%, or 22%. Use Form W-4V to inform the Social Security Administration of the amount you wish to have withheld from your tax.
Tax Withholding on Roth IRA Distributions
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Because you have already paid tax on contributions to a Roth IRA, qualified distributions are tax-free. Qualified distributions occur when you reach age 59 and a half or later, or if you become disabled, or for beneficiaries after your death.
If you take a non-qualified distribution (for example, before reaching age 59 and a half), it will be subject to a 10% tax penalty. If this amount was not withheld by your plan administrator, you will have to pay it as estimated taxes.
How Withholding Taxes Affects Your Taxes
Withholding taxes does not exempt retirement plan distributions from filing your taxes.
Like withholding taxes on wages, withholding taxes on distributions are taxes that are withheld from your income throughout the year. You will need to file your taxes by the tax day each year (usually April 15). You will need to report:
- All forms of your income, including your retirement plan distributions
- Taxes you have already paid
- Any tax credits or deductions you are entitled to
Note: If you have high income and few deductions, you may end up paying more in taxes than what was withheld from your distributions throughout the year. If you have lower income or more deductions, you may actually be entitled to a tax refund.
Frequently Asked Questions (FAQs)
Which states mandate withholding state tax on IRA distributions?
Not all states require state income tax withholding on IRA distributions. States that require income tax withholding from IRA distributions include Arkansas, California, Connecticut, Delaware, Iowa, Kansas, Maine, Massachusetts, Michigan, North Carolina, Oklahoma, Oregon, and Vermont. Each state has its own minimum thresholds and exceptions, so consult a tax or financial advisor if you are unsure how it works.
Are retirement plan distributions subject to withholding taxes?
Yes, retirement plan distributions are generally subject to federal income tax withholding.
Source: https://www.thebalancemoney.com/withholding-on-retirement-plan-distributions-3192942
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