Taxation of IRA Distributions
Individual retirement accounts, or IRAs, are tax shelters that defer the payment of income tax while the money is inside of the account. However, once the money is withdrawn, your IRA savings may be taxed. How this is handled depends entirely on the type of account you have. Make sure you understand how IRA distributions are taxed so that you can anticipate what your future tax liability will be.
Other People Are Reading
-
Types
-
There are two types of IRAs you can use to save for retirement. A traditional IRA allows you to make tax-deductible contributions. This means that you do not pay income tax on the contributions made to your retirement account. A Roth IRA only allows you to make after-tax contributions.
Significance
-
When you make tax-deductible contributions to a traditional IRA, you are taxed on all withdrawals made from the account. When you make withdrawals from a Roth IRA, the withdrawals are tax-free as long as the withdrawals are made after age 59 1/2.
-
Benefit
-
Since Roth IRAs do not tax distributions, you receive more net income from your retirement account. This means that you don't have to worry about future tax rates when saving money for your retirement. In addition, the Internal Revenue Service (IRS) allows you to remove contribution amounts prior to removing investment earnings. This means that you can actually make distributions prior to age 59 1/2 without paying tax or a penalty on the distribution amount.
Disadvantage
-
The disadvantage of IRA distributions lies primarily in traditional IRAs. Since all of the contribution amounts are tax deductible, the entire withdrawal is taxed at ordinary income tax rates. This may become problematic if you have accumulated a large IRA balance. Net income from a traditional IRA will be lower when compared with a Roth IRA, assuming all other factors remain equal.
-
