An individual retirement account (IRA) provides tax incentives for keeping your nest egg untouched until the age of 59 1/2. However, whether you’ve hit the 59 1/2 mark or are younger, you’ll face some tax implications when making withdrawals from your IRA. How much, if any in the case of Roth IRAs, tax needs to be withheld is largely based on your age, although a couple of other factors can also impact your tax liability with traditional IRAs, including what other income you have and how you choose to handle taxes (e.g., making estimated payments). Understanding all these factors can help you arrive at the right withholding for you.
Generally speaking, you should plan on withholding 10 percent of your traditional lRA withdrawals for tax purposes. If you begin withdrawing funds before the age of 59 1/2 however, you should plan on allotting an additional 10 percent for early distribution penalties.
Understanding Withholding Requirements
As noted on IRS.gov, "income tax is a pay-as-you-go plan." If you owe too much tax at the end of the year, you will be penalized for under withholding. You will not be penalized if at the end of the year you owe less than $1,000, you paid at least 90 percent of the taxes owed for the current year in advance or you paid 100 percent of the tax you owed for the prior year. Included in income for retirees could be traditional IRA distributions, income from other retirement plans and annuities, and dividends and interest. Part of your Social Security could also be taxed if your income exceeds certain levels.
Exploring Your Election Options
You have quite a bit of flexibility in determining whether to have taxes withheld from your IRA distribution and how much. For traditional IRAs, the plan custodian will typically withhold the default amount of 10 percent of your total withdrawal in accordance with Internal Revenue Service requirements. However, you can elect to have additional money withheld by informing the plan custodian of your election. If you live in the U.S., you can also elect not to have your plan administrator withhold any money for federal taxes but rather make estimated tax payments throughout the year or make it up by having more withheld from another distribution like a 401k plan from work. For Roth IRAs, taxes are paid on the front end, so qualified withdrawals are tax free.
Assessing State Tax
For all IRAs except Roth IRAs, state income tax may also be due on distributions . The rules and amounts will vary from state to state so you'll need to check with your state's department of revenue. Some states will also penalize you for under withholding just as the IRS does. Your plan custodian may or may not be willing to withhold state taxes for you, so you may be forced to pay estimated taxes throughout the year or have taxes withheld from another income source if possible.
Tax Penalty for Early Withdrawal
If for some reason you find that you have to dip into your nest egg before the age of 59 1/2, you’ll have to pay all the same taxes on your IRA distributions as anyone making a qualified withdrawal would. On top of that, you’ll also have to kick Uncle Sam an additional 10 percent early withdrawal penalty, unless you fall under a qualified exception. While the taxes and penalty do not apply to an early withdrawal of your Roth IRA contributions, they do apply to any earnings, which grow tax free within the plan. In addition, a Roth IRA must have been opened for at least five years to qualify for tax-free distributions.
Evaluating Hardship Withdrawals
The IRS does permit hardship withdrawals without financial penalties if there is an "immediate and heavy financial need." While there is no financial penalty, the amount is subject to tax at ordinary income rates. The hardship withdrawal is limited only to the amount the IRA owner actually requires for that financial need, so you must provide proof of the need's nature. The hardship withdrawal does not require repayment.
- Fidelity: IRA Tax Implications
- Internal Revenue Service: Retirement Plans FAQs
- Bob Carlson's Retirement Watch: Estimated Tax Strategies for Retirees
- Internal Revenue Service: Tax on Early Distributions from Traditional and ROTH IRAs
- IRS.gov. "Income ranges for determining IRA eligibility change for 2021." Accessed Oct. 30, 2020.
- Internal Revenue Service. "Publication 590-B (2018), Distributions from Individual Retirement Arrangements (IRAs)." Accessed Sept. 30, 2019.
- U.S. Congress. "H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019." Section 113.
Cynthia Gomez has been writing and editing professionally for more than a decade. She is currently an editor at a major publishing company, where she works on various trade journals. Gomez also spent many years working as a newspaper reporter. She holds a bachelor's degree in journalism from Northeastern University.