How Are Retirement Withdrawals Taxed?
When we talk about retirement income, I like to ask where you’d go for the money if you needed a new roof. Would you pull it from your traditional IRA, your Roth IRA, or a brokerage account? The same roof can affect your tax return differently depending on where the money comes from.
What happens when you take money from a traditional IRA?
If you deducted your contributions, you generally pay income tax on those dollars and their earnings when you take them out. If you also made nondeductible contributions, part of a withdrawal may represent money you’ve already paid taxes on. I like to look at what the withdrawal adds to your income for that year.
What about a Roth IRA or a brokerage account?
Qualified Roth IRA distributions are free of federal income tax. That can give you another place to turn in a year when you’re already expecting a larger taxable withdrawal. In a taxable brokerage account, if you sell an investment for more than its adjusted cost basis, you generally have a capital gain. How long you held the investment can affect how the gain is taxed.
Is a Roth conversion worth looking at before retirement?
Sometimes. A conversion moves money into a Roth IRA, and the portion that would have been taxable if withdrawn generally goes on your tax return in the year you convert. I’d compare the cost of converting with the taxes you might pay on future withdrawals. The years between your last paycheck and the start of other income can be a good time to run that comparison, especially if your taxable income dips.
When I sit down with a family, we look at what their regular spending requires and which years might bring a big expense. It’s easier to weigh your choices when you can see both on paper. If you’d like help thinking through which accounts could fund your retirement, you can reach our team atLegacyRetirementGroup.com.
For additional information and guidance regarding tax matters, please refer to the IRS Publication 590-B, IRS Tax Topic 409, and IRS Publication 17, or consult with a qualified tax professional regarding your individual circumstances.