How Taxes on Traditional IRA Distributions Work

Taxes on IRA withdrawals vary, depending on your deductions and income

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You can start taking distributions from your IRA without paying a tax penalty when you reach age 59 1/2, but the amount you withdraw may be subject to income taxes. It depends on the type of IRA you've established. Your annual distributions are included in the calculation of your total taxable income for that year.

Taxes on Roth IRAs vs. Traditional IRAs

The same rules do not apply to Roth IRAs. Roths are a quite different type of retirement account. Contributions made to a traditional IRA use pre-tax dollars. Roth contributions are made with post-tax dollars, which is is an important distinction. You've already paid income tax on that income in the year you earned it. You can therefore take distributions from your Roth IRA tax-free.

The Internal Revenue Service (IRS) won't tax you twice on the money you contribute to a Roth IRA, although you do have to maintain the account for at least five years, and, as with traditional IRAs, you must be at least age 59 1/2 before you take distributions to avoid a penalty. But you can take back your principal contributions even before age 59 1/2 as long as you don't touch any of the investment gains.

How to Report Your Traditional IRA Distributions

The total amount of tax you'll pay on your annual traditional IRA distributions depends on your overall income and the deductions you can claim that year.

The IRS, in cooperation with the Department of Treasury, completely revised the old 1040 in 2018 to accommodate the many tax law changes that had resulted from the Tax Cuts and Jobs Act (TCJA). You must still include all of the same information on your tax return as you did in the past, but you'll enter a great deal of it on additional forms and schedules.

You must still report your IRA distributions. The good news is that you won't have to worry about the proper form to use or where to enter the information if you use tax preparation software or hire a tax professional to prepare your return. Both know where to enter the appropriate information.

The 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 then reduced by allowable deductions, and the result is your taxable income.

You can expect to pay more tax on your IRA distributions than someone who has less 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 take a distribution before you reach age 59 1/2. You'll have to pay that in addition to income tax unless you qualify for an exception.

Allowable exceptions include using the money toward qualified education expenses. You can also use the money without penalty to purchase your first home. Other exemptions include disability, the death of the owner, unreimbursed medical expenses, and a call to duty if you're a military reservist.

You can also avoid the penalty if you "undo" your contribution and take it back before that year's extended due date for your tax return. But that move would mean more taxable income to you in that year. You can't claim a tax deduction for the reclaimed contribution.

Required Minimum Distributions

You can't take distributions too early, nor can you sit on your IRA and leave it untouched, growing and gaining forever. You must begin taking required minimum distributions (RMDs) if you reached age 70 1/2 in 2019 or earlier. You must begin taking RMDs by April 1 after the year you turn 72 if you reach age 70 1/2 in 2020 or later.

IRS rules pinpoint exactly how much of a distribution you must take each year, depending on factors that are unique to your circumstances. The penalty is even heftier than the 10% early withdrawal penalty if you fail to do so: 50% of the amount you were supposed to take, but didn't.

You can begin taking RMDs early to spread the tax hit out over more years. Nothing says you have to wait until age 70 1/2 or age 72. You just don't want to do it before you reach age 59 1/2.

What Happens If You Move Funds from a 401(k)?

You can move funds from a 401(k) into an IRA through a process called a "rollover." The funds aren't taxed when they're moved from the 401(k) plan, because they go from one qualified tax-deferred retirement account to another.

Rollover transactions have specific rollover rules, but you won't trigger any tax liability if the funds go directly from your 401(k) to the new IRA financial custodian, and if you never take possession of the money.

Funds can also be rolled over from one IRA to another if the money goes directly from the first plan's trustee to the second plan's trustee. You can't ever have possession of the funds. You'll have 60 days to reinvest the money in a new IRA to avoid taxation of the amount if you do take possession of the money, and you can only do that once a year.

Traditional IRA Distribution Taxation Example

Suppose you're single and 65 years old in 2022. You need IRA withdrawals to cover your living expenses. You must take $2,500 per month, or $30,000 per year, to make ends meet.

You'll have income of $12,000 from your pension in addition to this $30,000. That would give you an adjusted gross income (AGI) of $42,000 for the year, assuming that you can't take any adjustments to income to reduce that amount.

The first $10,275 of a single taxpayer's income is taxed at 10% in 2022. Your taxable income from $10,276 to $41,775 ($31,725) is taxed at a 12% rate. You'll therefore pay $4,834.50 in taxes: $1,027.50 on the first $10,275, plus $3,807 on the other $31,725.

Frequently Asked Questions (FAQs)

When do you pay taxes on IRA withdrawals?

You can either request that taxes be withheld from your distributions, or you can settle your tax debt when you file your tax return. Using the earlier example, you might have paid enough in taxes throughout the year to cover your tax liability of $4,834.50 if you had any taxes withheld from your IRA and pension distributions. You must pay the IRS by Tax Day (usually April 15) if you didn't pay that much through withholding.

What percentage of your IRA do you have to withdraw to satisfy your required minimum distributions?

You don't have to worry about required minimum distributions if you have a Roth IRA, unless you inherited it. The percentage gradually increases from roughly 3.6% at age 70 to more than 50% (at age 115) for traditional IRAs. You can use an IRS worksheet to figure out your percentage.

Article Sources

  1. Internal Revenue Service. "Publication 590-B (2020), Distributions from Individual Retirement Arrangements (IRAs)." Accessed Dec. 16, 2021.

  2. Internal Revenue Service. "Questions and Answers About the 2018 Form 1040." Accessed Dec. 16, 2021.

  3. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." Accessed Dec. 16, 2021.

  4. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs." Accessed Dec. 16, 2021.

  5. Internal Revenue Service. "Rollovers of Retirement Plan and IRA Distributions." Accessed Dec. 16, 2021.

  6. Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.” Accessed Dec. 16, 2021.