The purpose of retirement accounts is to encourage people to save for their golden years by offering them tax-deferred savings. Having a retirement account can help you feel more secure and provide income to help you pay your expenses. But for all their benefits, retirement accounts can cause headaches at tax time. In this post, we'll discuss the taxation of retirement account withdrawals to help take some of the confusion out of filing.
For most types of retirement accounts, you do pay taxes on withdrawals. This is because you didn't pay taxes on the money when you contributed. However, the IRS establishes different rules for various types of retirement accounts. Let's look at how withdrawals from various types are treated.
A 401(k) is a retirement plan you can pay into directly from your wages while you're employed by a for-profit company. Your employer sponsors the plan and may make contributions to it on your behalf.
Most 401(k)s are tax-deferred. Contributions are deducted from your paycheck before taxes are added, and you don't pay tax on interest, gains or dividends while your 401(k) grows. As a result, you need to pay when you make a withdrawal. If you're over the age of 59.5 years, the withdrawal is usually taxed like regular income. People under the age of 59.5 must pay penalties unless they qualify for an exception, such as getting divorced, becoming disabled or using the money to pay medical expenses.
A 403(b) plan is virtually the same as a 401(k), except you acquire this type of retirement account through an employer that's a nonprofit organization. Like 401(k)s, most 403(b) accounts are tax-deferred, so you'll typically need to pay taxes on withdrawals just as you do other types of income if you're 59.5 years or older.
A traditional individual retirement account (IRA) is a retirement savings plan you open yourself rather than getting through an employer. In some cases, contributions to IRAs are tax-deductible to encourage saving.
With traditional IRAs, you don't pay taxes on interest, gains or dividends while the balance grows. You'll instead pay taxes on your withdrawals. If you're at least age 59.5, the withdrawal is generally treated like income for tax purposes. People who are younger than 59.5 years old face penalties unless they meet the criteria for an exception.
A Simplified Employee Pension (SEP) is a retirement plan that small businesses make available for employees to enroll in. As with 401(k) and 403(b) accounts, SEPs often include contributions from employers and, in most cases, are tax-deferred. Generally, withdrawals from SEPs are taxable as income if you're 59.5 years or older. Younger people must pay penalties on top of taxes for early withdrawals unless they qualify for an exception.
The Roth IRA is another type of IRA that individuals can set up to save for retirement. With this type of retirement account, contributions aren't tax-deductible, but earnings aren't subject to taxes.
Because you don't receive tax benefits when you add money to a Roth IRA, you normally don't have to pay taxes on your withdrawals if you're over 59.5 years of age and have had your account for at least five years. If the account is less than five years old and you're at least 59.5 years old, you pay taxes on withdrawals as if they were income. People under 59.5 years old must pay penalties on IRA withdrawals unless they qualify for an exception.
How much you have to pay in taxes on retirement withdrawals varies based on your marginal tax bracket determined by your income. A certified public accountant (CPA) can help you calculate the correct amount and help you complete your tax return. The Missouri Division of Professional Registration offers a search tool. You can use it to find a CPA in the Creve Coeur area.
Residents of Autumn View Gardens senior living community can arrange transportation to a CPA's office for meetings. Make sure you bring your 1099-R form, which reports the amount of your withdrawal and any taxes already withheld.
If you're facing financial hardship and can't afford to pay the entire amount owed, the IRS suggests you file by the deadline and pay whatever you can. Provided the amount you owe is less than $25,000, you can include Form 9465 Installment Agreement Request and then make monthly payments over a five-year period. You'll be charged a fee for setting up the plan, but the penalty rate is much lower than what you'd face if you delay. To help make ends meet, look into financial assistance programs that serve seniors.
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