Withdrawals

Withdrawing funds from a retirement plan is commonly referred to as “taking a Distribution”.  You can take Distributions from your retirement plans at any time. All distributions will be reported on a Form 1099-R and must be reported on your Form 1040 or Form 1040-SR tax return in the year you received the distributions.  Whether a portion or all of each distribution must be included in your taxable income that year will depend upon the character of the distribution, and the IRS rules associated with each distribution.

Traditional Retirement Accounts (Pretax Contributions)

If you are under age 59½, such Distributions may also be subject to a 10% Federal early withdrawal penalty tax calculated on Form 5329, unless such Distributions qualify for one of the IRS exceptions listed here:  https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions . There is no exception to the 10% additional tax specifically for hardships. Generally it is not prudent to take early Distributions from your retirement accounts, as these funds will no longer be invested to capitalize on The Power of Compounding.

You received a reduction in your taxable income in each of the years that you made such pretax contributions into your retirement accounts.  Once you begin to take Distributions from your Traditional retirement accounts, you will need to pay Federal and State income tax (Massachusetts residents only) on the amounts withdrawn.

All Distributions received from your Traditional retirement accounts will be reported on a Form 1099-R for that tax year, with Code “7” recorded in Box 7 to indicate that these were normal distributions and must be included in your taxable income.

Roth Retirement Accounts (After Tax Contributions)

Unlike with Traditional retirement account distributions, your Roth distributions may or may not be included with your taxable income.

You may withdraw the contributions that you made into your Roth IRAs, 401(k) and 401(b) retirement plan accounts at any time, for any reason, without incurring and income tax or penalties, as long as it’s been as least five (5) years since you first made contributions into any Roth retirement account.  This is known as the “Five-Year Rule”. This is because you made those contributions with after-tax dollars, so you've already paid income taxes on that money.  This is one of the key reasons why Roth retirement accounts make such good after-tax savings accounts for teenage children, and for that matter, for all of us.

The IRS rules for withdrawing the earnings from Roth IRAs, 401(k) and 401(b) retirement plan accounts are different, however.  You may withdraw the earnings that were reported in your Roth IRAs, 401(k) and 401(b) retirement plan accounts at any time if you are at least age 59½.

For example, suppose that you are age 57 and opened your first Roth IRA in 2022.  You can tap earnings from this Roth IRA penalty-free at age 59 ½; however, you won't be able to tap earnings tax-free until 2027.
 
It's best to Roth account funds only if it's absolutely necessary.  If you must withdraw any money from a Roth account before retirement, you should limit it to contributions and avoid taking out any earnings.

Any Roth earnings Distributions received if the Five-Year Rule and age 59½ requirements are not met will be subject to a 10% Federal early withdrawal penalty tax calculated on Form 5329.  There is no exception to the 10% additional tax specifically for hardships.

However, if you take distributions of contributions from your Roth retirement accounts prior to the five (5) year holding period, such Distributions will be subject to a 10% Federal early withdrawal penalty tax calculated on Form 5329.
 
The ability to tap contributions from your Roth retirement accounts without penalty before age 59 1/2 allows for flexibility to utilize Roth accounts for other financial purposes.  In essence, a Roth account can act as an emergency fund that could be used to pay off significant unexpected medical bills or cover the cost of a child's education, if needed.

All Distributions from your Roth retirement accounts will be reported on a Form 1099-R for that tax year, with Code “B” recorded in Box 7 to indicate that such distributions were received tax-free as qualified distributions from designated Roth accounts.

Are My Retirement Distributions Taxable?

All retirement plan distributions, other than those from Roth IRAs or from Roth Employer-Sponsored Plans, are taxable as ordinary income in the year that you receive them.

Defined Benefit Plan distributions, more commonly known as a traditional Pension Plans, are also taxable as ordinary income on your Federal income tax return in the year that you receive them.  However, they are usually free from any State income tax.

In addition, up to 85% of the Social Security benefits you receive are taxable as ordinary income in the year that you receive them. The exact percentage is determined by your Adjusted Gross Income (AGI) as reported on your Federal Form 1040 income tax return each calendar year.

Tax Tip

If your Adjusted Gross Income (AGI) is more than $50,000 you should speak with your retirement plan administrator to have Federal income tax of 10% withheld from your plan distributions. If you are a Massachusetts resident, also have Massachusetts income tax of 5.0% withheld from your plan distributions.

You should also speak with the Social Security Administration to have Federal income tax of 10% withheld from your Social Security Benefits.

You really won’t miss these amounts withheld for income taxes in your day-to-day financial activities. By having such income taxes withheld regularly throughout the year, you will also lower the chance of receiving an unexpected tax bill when your tax returns are e-filed the following April.

If your Adjusted Gross Income (AGI) is more than $100,000 you should have Federal income tax of your Effective Tax Rate (ETR) withheld instead of the Federal income tax of 10% as discussed above.

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