Traditional IRAs and most employer-sponsored retirement plans are tax-deferred accounts, which means they are typically funded with pre-tax or tax-deductible dollars. As a result, taxes are not payable until funds are withdrawn, generally in retirement.
Withdrawals from tax-deferred accounts are subject to income tax at your current tax rate. In addition, taxable withdrawals taken prior to age 59½ may be subject to a 10% federal income tax penalty (a number of exceptions from the penalty tax are available).
If you made nondeductible contributions to a traditional IRA, you have what is called a “cost basis” in the IRA. Your cost basis is the total of the nondeductible contributions to the IRA minus any previous withdrawals or distributions of nondeductible contributions. The recovery of this basis is not counted as taxable income.
Exceptions are the Roth IRA and the Roth 401(k), Roth 403(b), and Roth 457(b). Roth accounts are funded with after-tax dollars; thus, qualified distributions (after age 59½ and the five-year holding requirement has been met) are free of federal income tax. (Even if a distribution from your Roth account isn’t qualified, you still receive your own Roth contributions back tax-free.)
Traditional IRAs, most employer-sponsored retirement plans, and Roth 401(k), 403(b) and 457(b) plans, are subject to annual required minimum distributions (RMDs) that must generally begin after you reach age 72. (The first RMD must be taken no later than April 1 of the year after the year in which you reach age 72.) Failure to take an RMD triggers a 50% federal income tax penalty on the amount that should have been withdrawn. Roth IRA owners never have to take RMDs; however, the designated beneficiaries of IRAs and employer-sponsored retirement plans do have to take RMDs.
When you begin taking distributions from your retirement accounts, make sure to pay attention to any required beginning dates and the appropriate distribution amount in order to avoid unnecessary penalties.
The information in this newsletter is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek advice from an independent tax or legal professional. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
Gerald R. Dewes does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.