When you contribute money to a traditional Individual Retirement Account (IRA), you deduct the amount you contributed from your income tax for the year. While you may save on taxes going into the IRA, you will have to pay tax on both the original amount of the IRA and any earnings on it, when you withdraw funds.
Income Tax
If you take a distribution, or withdraw, from a traditional or any type of IRA during the year, you must enter the amount on line 15 of IRS form 1040. You'll receive a 1099-R from the company that manages your IRA. In most cases, income tax will have already been withheld from your IRA distribution unless you specify that it not be withheld. The amount withheld will be printed on the 1099-R. In most cases, you'll complete Form W-4P, which states your marital status as well as any withholding allowances so that the proper amount of tax is taken out. The distribution is taxed based on your tax bracket when you withdraw the money.
Penalty Tax
You will have to pay a 10 percent penalty tax on most withdrawals taken from a traditional IRA before you turn 59 1/2-years-old. The 10 percent penalty is in addition to the regular income tax you would owe on the distributions. Depending on which state you live in, you may have to pay a state penalty tax for early distributions as well. If you contribute more than the maximum amount allowed to an IRA in a single year, you will have to pay a 6 percent tax on the excess amount every year it remains in the IRA.
Exceptions to the Penalty Tax
There are ways to withdraw from a traditional IRA early and avoid the penalty tax, but not the income tax. Use up to $10,000 from an IRA to pay for your first home without penalty. Other exceptions to the penalty include using money from your traditional IRA to pay for education expenses or to pay medical expenses that are more than 7.5 percent of your adjusted gross income. If you pass away, the person who inherits your IRA can withdraw funds without penalty. If you become disabled before age 59 1/2, you can take out money without penalty as well.
Age 70 1/2
When you have a traditional IRA, you must begin taking distributions by April 1 of the year after you turn 70 1/2. You need to withdraw a certain amount each year after age 70 1/2 to avoid paying a 50 percent excise tax on what the IRS considers "excess accumulations" in your IRA. To report this amount, you will need to complete form 5329 with your annual tax return.
