Federal Taxes on IRA Withdrawals
There are two primary types of individual retirement accounts: traditional IRAs and Roth IRAs. The Internal Revenue Service permits taxpayers to take an income tax deduction equal to their qualified contributions to a traditional IRA, while contributions to a Roth IRA must be made with after-tax dollars. Funds in both accounts are allowed to grow without incurring a current tax liability. A significant difference between Roth IRAs and traditional IRAs involves how withdrawals are taxed.
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Traditional IRA Qualified Withdrawal
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The funds in a taxpayer's traditional IRA always belong to the taxpayer, and she may withdraw funds from her IRA at any time for any reason. The government created IRAs to encourage taxpayers to save toward their own retirement. Certain tax advantages and penalties apply to funds in a traditional IRA based upon whether withdrawals from the account are qualified or non-qualified. The taxpayer may take qualified withdrawals from her traditional IRA once she reaches age 59 1/2. The taxpayer must report qualified withdrawals when she files her federal income taxes and these funds will be taxed as ordinary income at her current income tax rate.
Traditional IRA Non-Qualified Withdrawal
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If a taxpayer withdraws funds from his IRA prior to reaching age 59 1/2, the IRS will consider the withdrawal to be non-qualified. The taxpayer must report the withdrawal when he files his federal income tax return. His IRA trustee may withhold a percentage of the withdrawal for tax purposes. Withdrawn funds will be taxed as ordinary income at the taxpayer's current tax rate. The IRS will also impose a tax penalty equal to 10 percent of the amount withdrawn.
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Roth IRA Return of Contribution
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Roth IRAs are funded with after-tax dollars. Since the taxpayer has already paid income taxes on these funds, she may withdraw amounts equal to her contributions at any time for any reason. The IRS considers these withdrawals to be a return of regular contribution. These withdrawals are not subject to income taxes and the taxpayer does not need to include them with her gross income when she files her federal income tax return.
Roth IRA Withdrawals
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Qualified withdrawals from a Roth IRA refer to earnings from contributions to the IRA that have remained in the Roth IRA for at least five years and are withdrawn after the taxpayer reaches age 59 1/2. Qualified withdrawals from a Roth are free from federal income taxes. Non-qualified withdrawals refer to funds attributable as earnings that do no meet the definition of a qualified withdrawal. These funds are subject to taxation as ordinary income plus a tax penalty of 10 percent of the non-qualified amount.
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