How Much Tax Do I Have to Pay on My IRA Withdrawal?

Individual retirement accounts (IRAs) offer an excellent tax deduction for saving for retirement, yet when and how you withdraw can have a dramatic effect on how much is due in taxes and penalties.

Distributions from traditional IRAs and employer-sponsored retirement plans typically are subject to income taxes; however, exceptions do apply.

IRA Withdrawals

Individual Retirement Accounts, or IRAs, offer tax advantages when investing and saving for retirement. There are different kinds of IRAs such as traditional, Roth, SEP IRAs used by small business owners or self-employed individuals to save.

Every year, nondeductible contributions to a traditional IRA form part of its tax basis and are only counted as income upon withdrawal. To calculate this, divide the total nondeductible IRA contribution for that year by 1 and multiply it by 0.85 to get the percentage of taxable withdrawal.

Your IRA allows for partial withdrawals without incurring an early withdrawal penalty of 10% when used to buy your first home, pay qualified higher education expenses for yourself, your spouse, children or grandchildren, or meet disability expenses exceeding 7.5% of adjusted gross income.

Taxes

The tax liability associated with withdrawals from an IRA depends on several factors, including your age, contribution history and accuracy of tracking basis. Any distribution that is considered taxable should be added to your income tax bill in the year it was taken out.

Under certain conditions, withdrawals from an IRA could be made free from paying the 10% penalty, such as purchasing your first home for you or a family member; qualified medical expenses that don’t fall under insurance coverage and funeral costs.

Your IRA allows you to change its calculation method for required minimum distributions, but this requires using that new method with all future withdrawals. Before considering this option, consult a tax professional so they can explain its potential tax ramifications as well as assess whether a withdrawal is essential to reaching your retirement goals.

Penalties

Traditional IRA withdrawals made before age 59 1/2 may incur a 10% penalty; this policy aims to discourage individuals from withdrawing funds before needing them for income during retirement.

There are certain exceptions that allow individuals to forgo this penalty, including being disabled, using money for home buying expenses or incurring high medical costs, among other scenarios. Your tax advisor can help determine if an exemption applies in your situation.

In general, to avoid penalties you need to follow a plan called substantially equal periodic payments – however its rules can be fairly complicated.

Exceptions

There are certain exceptions to the 10% penalty associated with early withdrawals from traditional IRAs, including when buying your first home, paying unreimbursed medical expenses exceeding 7.5% of your adjusted gross income, or covering health insurance premiums for yourself, your spouse and any children when unemployed.

You may withdraw without penalty if you’re a first-time homebuyer and use the money to purchase a house for yourself, your spouse, child or any other relative – but only once in your lifetime! This exception can only be utilized once.

New York state and city tax exemptions provide for an annual $20,000 exemption on distributions from your private employer-provided retirement plans (401(k), 403(b)s, 457 plans) as well as traditional IRAs owned by you or held with an employer. Roth IRA withdrawals do not qualify. You should start taking required minimum distributions by April 1 of the year after attaining age 59 1/2 in a traditional IRA; required minimum distributions should commence as soon as you do so.


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