Do You Pay Taxes on an IRA After Retirement?
An Individual Retirement Account, or IRA, provides tax advantages when used for retirement savings. Contributions made to an IRA can be deducted from income taxes while earnings build tax-deferred until withdrawal at retirement age.
IRAs can be an invaluable asset for the 33 percent of workers without access to workplace retirement plans, yet some considerations must be made before opening an IRA account.
Taxes on IRA withdrawals
Many individuals rely on IRA withdrawals to meet financial needs, yet it’s crucial that they consider all of the tax ramifications. Not only could you lose money to taxes and penalties; you could also miss out on potential long-term growth from your IRA savings. Luckily, legal strategies exist that can help minimize tax liabilities.
As an example, you can withdraw penalty-free IRA funds to cover medical expenses that exceed 7.5% of your adjusted gross income (AGI). According to regulations, you may use these funds for out-of-pocket costs such as copays and coinsurance premiums, elective procedures, first time home purchases, tuition fees for yourself and/or your spouse or children and first-time home purchases.
At age 59 1/2 or above, you are eligible for penalty-free IRA withdrawals. Otherwise, any withdrawals from traditional, SEP, and SIMPLE IRAs will incur taxes as well as an early withdrawal penalty of 10% (unless an exception applies) that your tax advisor can inform you about.
Taxes on IRA rollovers
When rolling over distributions from employer retirement plans into individual retirement accounts (IRAs), tax rules differ considerably. For instance, if you were born before January 1, 1936 and made contributions after-tax before paying into an inherited IRA. Advisors must understand this intricate system so as to prevent clients from overpaying their taxes.
When making the switch from an employer-sponsored plan to an IRA, you have two choices for rolling over funds directly or indirectly. A direct rollover allows your current retirement plan administrator to send the assets directly to their new IRA custodian or trustee; then they can accept them electronically or via check. This method avoids income tax withholding.
Indirect rollovers require you to immediately take possession of and deposit any money you receive into an IRA within 60 days, otherwise, the IRS will treat the funds as taxable withdrawals and likely charge an early withdrawal penalty of 10%. Each year, it is also important that you report the value of your IRA when filing federal taxes as well as reporting requirements specific to states.
Taxes on IRA distributions
In general, withdrawals from an IRA are subject to your current individual income tax rate – which could be lower than your work-related tax rate. But there may be exceptions.
Your taxable withdrawals could vary depending on the type of IRA account you hold, but typically they’ll be partially or fully determined by how much after-tax contributions (nondeductible contributions) were made to it. When taking assets out of a Traditional, SEP or SIMPLE IRA that contains after-tax contributions (also called basis), proportionate to those nondeductible contributions are deducted as basis contributions from your withdrawal total.
If you are age 70 1/2 or above, the IRS mandates that you begin taking RMDs (Required Minimum Distributions). These must be reported on Form 1099-R and taxed according to your ordinary income tax rate.
Domestic abuse victims, unreimbursed medical expenses and emergency personal needs may qualify for penalty-free IRA withdrawals. Qualified reservists called into active duty can also make penalty-free IRA withdrawals.
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