Taxes on IRA Withdrawals
Withdrawing money from your Individual Retirement Account (IRA) may increase your tax burden for the year. Our comprehensive guide will teach you how taxes on IRA withdrawals work and how best to minimize the taxes you pay on that money.
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- Published: October 4, 2023
- Updated: October 6, 2023
- 7 min read time
- This page features 11 Cited Research Articles
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- You’ll owe income taxes on any income you withdraw from a traditional, SEP, SARSEP or SIMPLE IRA. Income taxes do not apply to withdrawals from Roth IRAs.
- If you withdraw money from your IRA before you reach the age of 59 1/2, you’ll owe an added tax penalty of 10% to 25%.
- You may be able to withdraw money from your IRA penalty-free if you use those funds for things like buying your first home or paying for higher education.
- You can avoid paying penalties on early IRA withdrawals by saving for emergencies, using a Roth conversion ladder or donating to charity.
Tax Impacts of Withdrawing From Your IRA
Depending on whether your retirement account is a Roth IRA or a traditional IRA, the money you withdraw from your IRA may be subject to federal income tax as well as state and/or local taxes if you live in an area that taxes income. Additionally, you may face an IRS penalty if you take out the funds too soon or if the withdrawal does not meet the criteria for a qualified distribution.
Understanding the specific rules and regulations governing your IRA will help you make informed decisions about your retirement savings. Moreover, knowing the changes in tax laws and retirement regulations can empower you to optimize your retirement planning and maximize your savings.
Although there are exceptions to early withdrawals from IRAs, they can be complicated and you should consult a financial advisor to help minimize any costs. In most cases, you’re probably better off trying to find an alternative financing option.
How Are Roth IRA Withdrawals Taxed?
Roth IRAs are retirement accounts funded with after-tax dollars. Your post-tax contributions mean you can withdraw your contributions from your Roth account at any age without paying more taxes on the money you put in.
However, you’ll still pay taxes on any investment earnings you withdraw or any other non-qualified distribution. You’ll also pay an extra 10% tax penalty on the non-qualified withdrawal.
A qualified distribution takes place at least five years after you first fund a Roth IRA account. You must also be at least 59 1/2 years of age, disabled or planning to use your money to buy a first home for yourself or a direct family member. Consult with a financial advisor before withdrawing money from your Roth IRA to confirm that you meet the qualifying criteria.
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How Are Traditional IRA Withdrawals Taxed?
You make contributions to traditional IRAs with pre-tax dollars. Because the money that goes in has yet to be taxed, any withdrawals and minimum required distributions from traditional IRAs are taxed as ordinary income, regardless of your age or circumstances. The tax rate depends on your income level at the time you take your money out. Depending on where you live, you may also owe state or local taxes on that income.
Although some exceptions exist, you may face a 10% penalty if you withdraw money from your traditional IRA before reaching the age of 59 1/2 years. Disabled people of any age can withdraw money from an IRA with no penalties.
You can also withdraw money penalty-free to cover certain expenses, including higher education fees, unreimbursed medical expenses that are more than 7.5% of your adjusted gross income (AGI), medical insurance premiums if you’re unemployed for at least 12 weeks and first-time home purchases. To be safe, talk to your financial advisor before making any withdrawals.
When Will You Owe Taxes on an IRA Withdrawal?
In most cases, you’ll have to pay taxes on any IRA withdrawals you make before you reach the age of 59 1/2 years. Withdrawals from traditional, SEP and SARSEP IRAs are taxed at your ordinary income tax rate no matter your age.
Additionally, the withdrawal amount is added to your ordinary income so you may be pushed into a higher tax bracket. If you pass away with money in your traditional IRA account, your beneficiaries may owe income tax on any withdrawals they make, depending on the circumstances.
There are special rules for inherited IRAs, so it’s a good idea for a beneficiary to consult a financial advisor to better understand the tax implications. They won’t owe income taxes from a Roth IRA withdrawal.
Making an early withdrawal from a traditional, SEP or SARSEP IRA will incur an extra 10% tax penalty. If you take money out of a SIMPLE IRA within the first two years of taking part in the plan, you’ll owe a 25% tax penalty. An early withdrawal of earnings from a Roth IRA could also be subject to the 10% penalty.
Tax penalties can eat into the money you take out. For example, if you withdraw $5,000 from a SIMPLE IRA that you’ve only been contributing to for one year, you will be left with only $3,750 before paying taxes on the distribution. Make sure your financial advisor weighs in before making an IRA withdrawal, to help you minimize any taxes.
Tips for Avoiding Early Withdrawal Penalties
Early withdrawal penalties for your IRA investments are almost always avoidable. Here are a few tips to help you minimize the penalties you pay.
- Understand the Rules
- Knowing what may trigger a penalty will help you avoid doing so by accident.
- Plan for Qualified Distributions
- If you know you’ll need money for an upcoming purchase, plan your withdrawal for when it will count as a qualified distribution.
- Explore Exceptions
- You may avoid early withdrawal penalties if you have a disability or if you need the money to buy a house, pay for school or settle medical bills.
- Consider a Roth Conversion Ladder
- Roth conversion ladders let you transfer a small part of the funds in a traditional IRA to a Roth IRA each year and pay taxes at the time of the transfer. You can then withdraw that money later without paying income tax on it.
- Use Other Sources of Funds First
- Taking money out of your IRA early should be a last resort. If you can get money from somewhere else, try that first.
- Explore Loans Instead of Withdrawals
- In some cases, interest fees on a loan may be lower than tax penalties on a withdrawal.
- Establish an Emergency Fund
- If you have money saved for emergencies, you’ll be less likely to need your IRA to help.
- Donate to Charity
- You can transfer up to $100,000 from your IRA to a charity tax-free each year through what’s known as a Qualified Charitable Distribution.
Just as you did with your retirement planning, consult with a financial advisor or tax professional before making any unscheduled withdrawals from an IRA. Either can help you decide how to get the money you need while paying as little tax as possible.
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11 Cited Research Articles
- Wohlner, R. (2023, June 29). How to Make Roth IRA Withdrawals Tax- and Penalty-Free. TIME Stamped. Retrieved from https://time.com/personal-finance/article/roth-ira-withdrawal-rules/
- Internal Revenue Service. (2023, April 5). Publication 590-B (2022), Distributions from Individual Retirement Arrangements (IRAs). Retrieved from https://www.irs.gov/publications/p590b
- Iacurci, G. (2023, February 6). Roth IRA ‘five-year rule’ can trigger an unexpected tax bill: Here’s what you need to know. Retrieved from https://www.cnbc.com/2023/02/06/roth-ira-five-year-rule-heres-what-you-need-to-know.html
- Internal Revenue Service. (2022, December 21). Salary Reduction Simplified Employee Pension Plan (SARSEP). Retrieved from https://www.irs.gov/retirement-plans/plan-sponsor/salary-reduction-simplified-employee-pension-plan-sarsep
- Internal Revenue Service. (2022, December 21). SIMPLE IRA Plan. Retrieved fromhttps://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan
- Internal Revenue Service. (2022, December 21). Simplified Employee Pension Plan (SEP). Retrieved from https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep
- Internal Revenue Service. (2022, December 9). Retirement Topics – Beneficiary. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary
- Internal Revenue Service. (2022, November 18). Reminder to IRA owners age 70½ or over: Qualified charitable distributions are great options for making tax-free gifts to charity. Retrieved from https://www.irs.gov/newsroom/reminder-to-ira-owners-age-70-and-a-half-or-over-qualified-charitable-distributions-are-great-options-for-making-tax-free-gifts-to-charity
- Internal Revenue Service. (2022, September 19). Retirement Topics – Exceptions to Tax on Early Distributions. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions
- Bureau of Labor Statistics. (2013, Fall). Saving early for retirement. Occupational Outlook Quarterly. Retrieved from https://www.bls.gov/careeroutlook/2013/fall/art02.pdf
- Internal Revenue Service. (2010). Roth Conversions/Retirement Planning for Life Events. Retrieved from https://www.irs.gov/pub/irs-tege/forum10_roth_conversions.pdf
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