How will my IRA withdrawal be taxed?
June 18, 2012
Q: If I make a withdrawal of $6,000 our of my IRA money market account, what can I expect the tax to be?
A: Tax questions don't lend themselves to one-size-fits-all answers, but the important thing is that you are looking before you leap by asking this question before you make the withdrawal. There are three key variables that will determine whether all or part of your withdrawal is taxable, and how much tax will be assessed on that withdrawal. By understanding these variables, you can assess how the rules are likely to affect your situation.
Here are those key variables:
- Is it a traditional or a Roth IRA? Since contributions to traditional IRAs are tax-deductible, you have to pay tax on the back end, which is when the money is withdrawn from the IRA. Therefore, all of a traditional IRA withdrawal is likely to be taxable. Roth IRAs, on the other hand, are funded with money that has already been taxed. Therefore, upon withdrawal from Roth IRAs, only the amount you earned while the money was in the IRA should be subject to taxation. Given that your IRA is a money market account, and given how low money market rates have been in recent years, there is a good chance that the vast majority of your distribution will be exempt from taxation -- if it is in a Roth IRA.
- What is your age? In addition to regular income tax, you may also face a 10 percent tax penalty on your withdrawal if you are less than 59 1/2 years old, or if it is a Roth IRA that has been funded for less than five years.
- What is your tax bracket? Whether all or part of your distribution is subject to income tax, the exact amount of that tax will depend on your tax bracket. This is a key part of the strategy regarding when to withdraw money from an IRA. Many people expect to be in a lower tax bracket when they are older and earning less money, though there is always the possibility that tax rates may be raised or lowered by the government.
The above are the most common determinants of IRA tax treatment, but there are other variables that can affect IRA withdrawals, such as whether the withdrawal is the result of a disability, or going to pay for a first home. For more detailed information, see IRS publication 590.
Again, the important thing is to consider these things before you make your withdrawal, because taking money out of an IRA is a bit like taking toothpaste out of the tube -- once you've done so, it can be very messy trying to put it back in.
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