The way individual retirement account (IRA)withdrawals are taxed depends on the type of IRA. For example, you'll always pay taxes on traditional IRA withdrawals. But with a Roth IRA, there is no tax due when you withdraw contributions or earnings, provided you meet certain requirements.
Early withdrawals—those that happen before age 59½—from any qualified retirement account, including IRAs and 401(k) plans, come with a 10% penalty. Early withdrawals also trigger income taxes on the distributed amounts, though there are some exceptions to this rule.
Key Takeaways
- Contributions to traditional IRAs are tax deductible, earnings grow tax-free, and withdrawals are subject to income tax.
- Roth IRA contributions are not tax-deductible, earnings grow tax-free, and qualified withdrawals are tax-free.
- Because contributions to Roth IRAs are made with after-tax money, you can withdraw them at any time, for any reason, with no tax or penalty.
- Early withdrawals (before age 59½) of funds from a traditional IRA and earnings from a Roth IRA are generally subject to a 10% penalty, plus taxes, though there are exceptions to this rule.
How Traditional IRA Withdrawals Are Taxed
With a traditional IRA, withdrawals are taxed as regular income (not capital gains) based on your tax bracket in the year of the withdrawal. In 2023, there were seven federal tax brackets in the U.S., ranging from 10% to 37%.For 2024, the same seven rates exist–ranging from 10% to 37%--but the income ranges that define each bracket have changed.
Here are two examples:
- In 2023, for married couples filing jointly the 22% bracket went from taxable income of $89,451 to $190,750.
- In 2024 that bracket goes from $94,301 to $201,050.
With a traditional IRA, the idea is that you ought to be subject to a higher marginal income tax rate while you are working and earning more money than when you have stopped working and are living off of retirement income. Of course, sometimes the opposite happens; some retired people have higher income than they did while they were younger and still working.
Both traditional and Roth IRAs are subject to the same annual contribution limits. The limit is $6,500 for 2023. That increases to $7,000 for 2024. If you are 50 or older, you can contribute up to an additional $1,000 catch-up contribution for a total of $7,500 for 2023 and as much as $8,000 in 2024.
Both traditional and Roth IRAs are subject to the same annual contribution limits. The limit is $6,500 for 2023 (increasing to $7,000 in 2024). If you are 50 or older, you can contribute an additional $1,000catch-up contribution for a total of $7,500 in 2023 or $8,000 in 2024.
Qualified Traditional IRA Withdrawals
Although withdrawals are taxed the year you make them, there are no additional penalties if you're at least 59½ or use the funds for a qualified purpose.
Qualified purposes for an early withdrawal from a traditional IRA include a first time home purchase (on up to $10,000 of the withdrawal), qualified higher education expenses, qualified major medical expenses, certain long-term unemployment expenses, or having a permanent disability.
Deducting Traditional IRA Contributions
Traditional IRA contributions can be fully or partially tax-deductible based on your modified adjusted gross income (MAGI) if you contribute to an employer-sponsored plan, such as a 401(k).
For 2023, the phase-out range (where the size of your deduction is reduced) for single tax filers is between MAGI of $73,001 and $83,000 (rising to between $77,001 and $87,000 for 2024). For married couples filing jointly, the 2023 phase-out range is between $116,001 and $136,000. That rises to between $123,001 and $143,000 in 2024.7 Unlike Roth IRAs, there are no income limits on who can contribute to a traditional IRA.
Owners of traditional IRAs (and 401(k) plan participants too) must begin taking annual required minimum distributions RMDs, which are subject to taxes, at the age of 72. But there is an exception. Your RMDs must start at age 73 if you reach age 72–not 73–after Dec. 31, 2022.
How Roth IRA Contributions Are Taxed
Because you make Roth IRA contributions with after-tax dollars, you can withdraw them tax-free at any time with no tax or penalty. But this also means contributions are not tax deductible like those made to traditional IRAs. And keep in mind that you can only contribute earned income to a Roth IRA.
Earned income is money you receive for working, such as wages, salaries, bonuses, commissions, tips, and net earnings fromself-employment. Conversely, income derived from investments and government benefit programs is considered unearned income.
Qualified Roth IRA Withdrawals
You can withdraw earnings without penalties or taxes as long as you’re 59½ or older and have had a Roth IRA account for at least five years. Although it can be hard to predict, a Roth IRA may be a good choice if you think you will be in a higher tax bracket when you retire.
The five-year clock starts on Jan. 1 of the year you make your first contribution to a Roth IRA. And it can be any Roth IRA, not just the one from which you’re making a withdrawal.
Like a traditional IRA, you can avoid the 10% penalty for early withdrawals if you use the money for a first-time home purchase, qualified education expenses, medical expenses, or if you have a permanent disability. However, you might still pay taxes on the amount withdrawn, depending on how long it's been since you first contributed to a Roth.
Roth IRA Income Limits
Not everyone is eligible to contribute to a Roth IRA. Unlike a traditional IRA, there are income limits. For 2023, only individuals with a MAGI of $153,000 (increased to $161,000 in 2024) or less are eligible to participate in a Roth IRA. The phase-out for singles starts at $138,000 for 2023. It rose to $146,000 for 2024.
For those married filing jointly, the 2023 MAGI limit is $228,000 (which increased to $240,000 for 2024), with a phase-out starting at $218,000 ($230,000 for 2024).If you earn too much to contribute to a Roth directly, you might be able to make contributions indirectly via a strategy known as a backdoor Roth IRA.
How Much Tax Do You Pay on IRA Withdrawals?
That depends on several factors, including the type of IRA, your age, and how long it's been since you first contributed to an IRA. If you have a Roth IRA, you can withdraw your contributions at any time with no tax or penalty. To withdraw your earnings, you must wait until you're 59½ or older, and it's been at least five years since you first contributed to a Roth IRA to avoid taxes and penalties.
Withdrawals from traditional IRAs are subject to income taxes at your ordinary tax rate, and early withdrawals may be subject to a 10% penalty tax. There are exceptions to the rules that allow early withdrawals without triggering the penalty and taxes.
When Do RMDs Start?
RMDs only apply to traditional IRAs; there are no RMDs for Roth IRAs during the account owner's lifetime. The SECURE Act of 2019 raised the RMD age for traditional IRAs to 72 from 70½. The Consolidated Appropriations Act of 2023 raised the age for RMDs to 73 for anyone born between (and including) Jan. 1, 1951, and Dec. 31, 1959. The age increases in 2033 to 75 for anyone born on Jan. 1, 1960, or later.
How Are RMDs Calculated?
RMDs are generally calculated by dividing the account's prior Dec. 31 balance by the appropriate life expectancy factor the IRS publishes in Publication 590-B, Distributions from IRAs. You must calculate the RMD separately for each IRA you own, but you can withdraw the total amount from one or more IRAs.
The Bottom Line
The withdrawal rules for IRAs depend on the type of IRA, your age, and how long it's been since you first contributed to an IRA. In general, Roth IRAs offer more flexibility because you can withdraw your contributions at any time, qualified withdrawals are tax-free, and they aren't subject to RMDs during the account owner's lifetime.
On the other hand, traditional IRA withdrawals are taxed at your ordinary income tax rate, and you must start taking RMDs the year you turn 72 or 73, depending on your birth date, as we described earlier in this report. The penalty for not taking RMDs is steep: Whether you fail to take the RMD by the deadline or don't withdraw enough, the amount not withdrawn is taxed at 25%. You might be able to have the penalty reduced to 10% if you fix the issue within the correction window, which generally begins on Jan. 1 of the year following the RMD mistake.
Retirement Security Rule: What It Is and What It Means for Investors
The purpose of the Retirement Security Rule, also known as the fiduciary rule, is to protect investors from conflicts of interest when receiving investment advice that the investor uses for retirement savings.
The rule was issued by the U.S. Department of Labor (DOL) on April 23, 2024. It takes effect on September 23, 2024. However, a one-year transition period will delay the effective date of certain conditions to 2025.
If an advisor is acting as a fiduciary under the Employee Retirement Income Security Act (ERISA), they are subject to the higher standard–the fiduciary best-advice standard rather than the lower, merely suitable advice standard. Their designation can limit products and services they are allowed to sell to clients who are saving for retirement.
