Individual retirement accounts offer special tax incentives with the intention of promoting saving money for retirement. An IRA disbursement must always be reported as income on your tax return, but it won't always be taxable. The taxability depends on whether your taking disbursements from a Roth or traditional IRA and whether you're taking qualified or nonqualified distributions.
Although IRA disbursements are reported as income on your tax return, this doesn't necessarily mean that you will owe taxes on this money.
Traditional IRA Withdrawals
Traditional IRA disbursements always count as taxable income unless you've made nondeductible contributions to the account, regardless of whether you're taking a qualified or nonqualified distribution. However, if you take a nonqualified withdrawal, you also pay an early withdrawal tax penalty of 10 percent. For traditional IRAs, qualified withdrawals are any disbursements taken after you turn 59 1/2 years old.
Nondeductible Contribution Effects
If you've made nondeductible contributions to your traditional IRA, your calculations get a bit trickier. To figure the nontaxable part, divide the amount of nondeductible contributions in your IRA by the total value when you take the distribution. For example, if you have $17,000 of nondeductible contributions in your IRA worth $100,000, 17 percent of your withdrawal is tax-free. The remaining 83 percent is taxable. For example, if you took out $1,000, $170 would be tax-free and the remaining $830 would be taxable.
Roth IRA Qualified Withdrawals
Qualified withdrawals from Roth IRAs count as nontaxable income for tax purposes. You'll have to report the money on your income taxes, but you won't have to pay any taxes on it, even if you're withdrawing the earnings on your contributions. To take a qualified withdrawal, you must satisfy two conditions. First, you have to be 59 1/2 years old, permanently disabled or a first-time homebuyer withdrawing no more than $10,000 for the purchase. Second, five years or more must have elapsed since Jan. 1 of the first tax year you made a contribution to the IRA.
Roth IRA Early Withdrawals
If you're not able to take a qualified withdrawal from your Roth IRA, you might have to treat some or all of your distribution as taxable income. First, you get to remove contributions from your Roth IRA as nontaxable income. Then you take out the earnings, which count as taxable income. In addition to income taxes, a 10 percent early withdrawal penalty applies to the earnings, unless you qualify for an exception.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."