What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


How Much Should I Withhold on My IRA Distribution?

Original post by Rocco Pendola of Demand Media

To determine the exact amount of money you should withhold from an IRA distribution, you need to consider several factors specific to your situation. In some cases, general rules of thumb apply; however, much of the time, the circumstances surrounding the withdrawal as well as your annual income dictate how much it makes sense for you to withhold.

Contents

Account Types and Timing

If you have owned a Roth IRA for at least five years and wait until you turn age 59 1/2 to withdraw money, the IRS does not require you to pay taxes on any portion of the withdrawal. While exceptions apply (refer to IRS Publication 590), if you do not satisfy the five-year rule and/or take a Roth distribution prior to age 59 1/2, the IRS collects regular income tax on any earnings that accumulated in the account that you access. With a traditional IRA, the IRS charges regular income tax on all withdrawals, regardless of time and circumstance.

The Law

When you remove money from a traditional IRA, the IRS requires your IRA custodian to withhold 10 percent of the withdrawal for taxes. You have the option of changing this amount to any number between 10 and 99 percent or asking that the custodian not withhold any federal income tax. For a Roth IRA, the custodian does not, by default, withhold the above-mentioned 10 percent. Consult your tax advisor or state tax office to determine how your state treats IRA withdrawals. Your custodian will abide by the tax laws that govern the state of the legal address it has on file for you.

Early-Withdrawal Penalty

When you take an early distribution from an IRA -- and an exception does not apply -- the IRS levies a 10-percent excise tax on the withdrawal in addition to any regular income tax due. Your IRA custodian reports your IRA distributions for a given year to the IRS on Form 1099-R. If you have taken an early distribution that warrants the 10-percent penalty, your custodian notes this in Box 7 of Form 1099-R with a special code.

Considerations

Ultimately, you control how much money your IRA custodian withholds from your IRA distribution. You can choose to withhold an estimate of what you think you will owe, based largely on your tax bracket at the time of the distribution, or wait to settle up with the IRS at tax time. When you file your taxes, you must report the information from any 1099-Rs that you receive. Your tax advisor or tax software will adjust your income tax due accordingly. Remember, your custodian sends the IRS a copy of your 1099-Rs; therefore, the IRS has this information and knows what to expect on your return.


                   

Resources

References

About the Author

As a writer since 2002, Rocco Pendola has published numerous academic and popular articles in addition to working as a freelance grant writer and researcher. His work has appeared on SFGate and Planetizen and in the journals "Environment & Behavior" and "Health and Place." Pendola has a Bachelor of Arts in urban studies from San Francisco State University.


Advertisement