Federal Tax Rules on IRA Withdrawals

Even tax-free IRA withdrawals must show up on your tax return.

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The federal tax rules for individual retirement account distributions differ depending on whether you're taking money out of a Roth IRA or a traditional IRA. Traditional IRAs offer tax-deferred savings because contributions may be deductible, while Roth IRAs offer after-tax savings, which means your contributions never result in a tax deduction.

Ordinary Income Treatment

No matter how you invested the money in your IRA, all your withdrawals count as ordinary income. As a result, you won't pay the lower capital gain rates even if you've invested in stock or other capital assets that you've held for over a year. Instead, you always pay taxes on IRA distributions at your marginal tax rate.

Early Withdrawal Penalties

You can get your money out of an IRA at any time, though you might have to pay an extra 10 percent early withdrawal penalty on the taxable portion of the distribution. For traditional IRAs, you can avoid the penalty by waiting until you are 59-1/2-years-old to take distributions. For Roth IRAs, you must wait until the account has been open for five years and either you are 59-1/2-years-old, permanently disabled or taking out up to $10,000 as a first-time home buyer. Exceptions to the penalty include higher education expenses and medical insurance premiums while unemployed.

Traditional IRA Distributions

Traditional IRA distributions are taxable except in cases where you've made nondeductible contributions to the account. Nondeductible contributions refer to money you put in that you didn't claim a deduction for on your tax return, either because you were covered by an employer plan and your income was too high or simply because you chose not to take the deduction. If you've made nondeductible contributions, the percentage of nondeductible contributions in your account at the time of the distribution equals the percentage of your distribution that comes out tax-free. For example, suppose your nondeduction contributions account for 19 percent of your traditional IRA value when you take your distribution. In this case, 19 percent of your withdrawal is tax-free.

Roth IRA Distributions

All qualified Roth IRA distributions escape federal income tax, as do early distributions of your contributions. To take a qualified distribution, you must wait five years after you open your Roth IRA and be at least 59-1/2-years old, permanently disabled or taking out no more than $10,000 to buy a first home. If you're not qualified, you take out your contributions first, and don't have to pay taxes or penalties. But after you've withdrawn all your contributions and start taking out earnings early, those earnings are taxed and penalized.