Taxation of Retirement Plan Distributions

The specific rules regarding taxation of retirement plan distributions depend on the type of retirement account you’ve established and when you receive your distributions. Taxation directly affects the amount of money available for retirement, and there are a plethora of tax rules for retirement account distributions.

Roth IRA

The contributions you make to a Roth IRA are after-tax, and investments within your account grow on a tax-free basis. When you receive qualified distributions from your Roth IRA, you are not required to pay income tax on the money received. The IRS defines qualified distributions as payments made on or after you reach age 59 1/2. Qualified early distributions include payments made because you suffered a disability, payments made toward the purchase of your first home and payments made to your beneficiary or estate after your death. You must receive early distributions at least five years from when you set up and contributed to your Roth IRA for the IRS to consider them qualified distributions.

Tax-deferred Retirement Plans

A tax-deferred retirement account allows you to contribute to your plan on a pretax basis and defer your income tax requirement until you withdraw money. Examples of tax-deferred accounts include a 401(k), 403(b) and traditional and SEP IRAs. You must pay federal income tax on distributions according to your current tax bracket. A tax-deferred plan includes the same qualified early distribution rules as a tax-free account, in addition to several other rules. If you invest in a 401(k) or 403(b) plan, you are exempt from distributions if you are age 55 and older and you retired or left your job. This exemption does not apply to SEP and traditonal IRAs. You also qualify if distributions are made to an alternate payee under a qualified domestic relations order.

Annuities and Pensions

If you enroll in an employer-sponsored pension or invest in an annuity, you are entitled to receive periodic payments beginning at the date specified in the plan. The periodic payments you receive are fully taxable if you did not pay anything for your annuity or pension, or if your employer did not withhold contributions for your paycheck. You must report taxable payments as income on your tax return. After-tax contributions you made into an annuity or pension are partially taxable. The contributions are deducted from your periodic payments because they are considered a cost you incurred. The difference between the payment and your monthly contribution amount is taxable.

Early Distributions

The IRS seeks to discourage you from using funds in your retirement plans for anything other than normal retirement. Federal law requires you pay federal income tax and a 10 percent additional tax on unqualified distributions made from your retirement account before age 59 1/2. You must report the additional tax on your tax return using Form 1040 or Form 5329, depending on your tax situation.