If you’re 59 ½ or older you’re usually all clear. But if you’re younger than that, you will get hit with a penalty for early withdrawals from traditional IRAs, or early withdrawals on earnings from Roth IRAs.
Your withdrawals from a Roth IRA are tax free as long as you are 59 ½ or older and your account is at least five years old. Withdrawals from traditional IRAs are taxed as regular income, based on your tax bracket for the year in which you make the withdrawal.
You can avoid the early withdrawal penalty by waiting until at least age 59 1/2 to start taking distributions from your IRA. Once you turn age 59 1/2, you can withdraw any amount from your IRA without having to pay the 10% penalty. However, regular income tax will still be due on each IRA withdrawal.
Here’s how to minimize 401(k) and IRA withdrawal taxes in retirement:
You can withdraw Roth IRA contributions at any time, for any reason, without paying taxes or penalties. If you withdraw Roth IRA earnings before age 59½, a 10% penalty usually applies. Withdrawals before age 59½ from a traditional IRA trigger a 10% penalty tax, whether you withdraw contributions or earnings.
If you withdraw money from a traditional IRA before you turn 59 ½, you must pay a 10% tax penalty (with a few exceptions), in addition to regular income taxes. Plus, the IRA withdrawal would be taxed as regular income, and could possibly propel you into a higher tax bracket, costing you even more.
Unless you’ve instructed us not to withhold taxes, the IRS requires us to withhold at least 10% of distributions from traditional, SEP, and SIMPLE IRAs. If your distributions are delivered outside the U.S., we’re required to withhold 10% federal income tax.
If you’re 65 and older and filing singly, you can earn up to $11,950 in work-related wages before filing. For married couples filing jointly, the earned income limit is $23,300 if both are over 65 or older and $22,050 if only one of you has reached the age of 65.
All of the money in your traditional IRA belongs to you. You must begin taking minimum withdrawals from your traditional IRA in the year you turn age 70 1/2. The amount you withdraw at that time is taxed as ordinary income, but the funds that remain in your IRA continue to grow tax deferred regardless of your age.
Most people age 70 are retired and, therefore, do not have any income to tax. Common sources of retiree income are Social Security and pensions, but it requires significant planning prior to the taxpayer turning age 70 in order to not have to pay federal income taxes.
Long-term capital gains tax is a tax applied to assets held for more than a year. The long-term capital gains tax rates are 0 percent, 15 percent and 20 percent, depending on your income. These rates are typically much lower than the ordinary income tax rate. 6
Retirement withdrawals do not count toward the Earned Income Limitation. The limitation applies to income from labor such as wages, salary, or self-employment income. A $25,000 IRA distribution would add more than $25,000 of taxable income.
Do 401(k) and IRA distributions count toward the Social Security earnings limit? No. It does not take into account pensions, retirement-account distributions, annuities, or the interest and dividends from your savings and investments.
In most ways, money you take out of your IRA is just like your wages. The big difference is that you don’t pay FICA taxes on your IRA withdrawals. That means you don’t pay Social Security and Medicare taxes on your IRA withdrawals. Also, you can withdraw as much as you want, and still not owe the FICA taxes.
There’s no limit to how much you can withdraw from your IRA annually – it’s a question of how much to need to take out. You want to take out enough for your current needs while keeping enough back so that you don’t outlive your retirement funds.
Take the total amount of nondeductible contributions and divide by the current value of your traditional IRA account — this is the nondeductible (non-taxable) portion of your account. Next, subtract this amount from the number 1 to arrive at the taxable portion of your traditional IRA.