Individual Retirement Accounts, or IRAs, are investment and savings accounts intended to cover expenses during retirement. People like them because they offer some tax advantages. However, IRAs are not tax-free. The amount of tax you pay on an IRA distribution is a combination of factors, including your tax bracket, the type of IRA you have, when you take the distribution and the purpose for the withdrawal.
The Internal Revenue Service usually taxes IRA funds as ordinary income. However, you get to choose when you pay the tax depending on what type of IRA you have. With a traditional IRA, the money you put in is tax-deferred. The IRS taxes the money when you take a distribution. With a Roth IRA, just the opposite is true. You pay the taxes upfront so that the IRS doesn't tax you when you take the money out.
Because the IRS treats IRA funds as ordinary income, whatever taxes you have to pay on the money depends on your tax bracket. The more income you have, the greater the hit you take for the distribution. For example, as of 2011, the federal tax bracket for a single person making $8,500 per year or less was 10 percent. For a single person earning $379,151 or more, the tax was 35 percent. If your income changes significantly -- this often happens with major career or life changes, medical issues or additional education -- where you sit in the tax brackets may shift. That means you cannot assume that the amount of tax you will pay on your IRA distributions will be the same throughout your life.
In addition to considering the income-tax treatment of IRA funds, you also have to look at when you take the distribution. This determines whether the IRS assesses additional penalties on top of the income tax you pay. If you take a distribution prior to age 59 1/2, the IRS tacks on a penalty of 10 percent. For Roth IRAs, this applies only if your distribution dips into the IRA earnings or funds you transferred from a traditional IRA. If you are between the ages of 59 1/2 and 70 1/2, there usually are not any penalties. If you take the distribution after age 70 1/2 and have a traditional IRA, you have to take a required minimum distribution, or RMD, at least once a year. If you don't take the full RMD, the penalty is half of the remaining RMD amount. For instance, if you were supposed to take $300 and took $200, the penalty would be half of the remaining $100, or $50. Roth IRAs do not have RMDs, so RMD penalties don't apply for those IRAs.
Exceptions to Penalties
Even though penalties sometimes apply to IRA distributions, the IRS provides some exceptions. For example, you don't have to pay the 10 percent penalty if you use the distribution for academic purposes or a first-time home. Why you want the distribution therefore impacts how the IRS treats it.
Wanda Thibodeaux is a freelance writer and editor based in Eagan, Minn. She has been published in both print and Web publications and has written on everything from fly fishing to parenting. She currently works through her business website, Takingdictation.com, which functions globally and welcomes new clients.