Before you withdraw funds, understand the IRS rules for retirement plan distributions.
One of the more challenging aspects of retirement income planning is knowing and following the IRS rules for withdrawing money from various retirement accounts.
We can help you avoid penalties when withdrawing retirement assets while also incorporating tax diversification and withdrawal strategies to help you keep more of your money.
Here’s a guide to retirement distribution rules for the most common retirement accounts, including how they’re taxed, whether they’re subject to the IRS required minimum distribution (RMD) rules and the penalties you may face for taking out money early.
Traditional IRAs
A traditional IRA is an individual retirement account that allows you to contribute pretax or after-tax dollars. Contributions may be tax deductible depending on your situation.
How distributions are taxed | - Distributions of pretax contributions and earnings are normally taxed as ordinary income.*
- Distributions of after-tax contributions are not subject to income tax.
- If both pre- and after-tax contributions have been made, distributions are taken from both proportionally, in accordance with the IRS pro rata rule.
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| - A 10% penalty may apply to taxable distributions made prior to age 59½ (though certain exceptions apply).
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Roth IRAs
A Roth IRA is an individual retirement account funded with after-tax dollars.
How distributions are taxed | - Distributions of contributions and conversion assets are always income-tax free.
- Qualified distributions of earnings are also tax-free.
- Non-qualified distributions of earnings are taxed as ordinary income.*
- Contributions are distributed first, followed by Roth conversion assets and then earnings.
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| - You can withdraw your principal contributions from a Roth IRA at any time before age 59½ without penalties.
- Withdrawing any capital gains before age 59½ is subject to a 10% penalty.
- A 10% penalty may also apply to distributions of assets converted to a Roth IRA if made within five years of conversion, although exceptions may apply.
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A SIMPLE IRA (Savings Incentive Match Plan for Employees) is an employer-sponsored plan designed for small businesses, limited to businesses with 100 employees or fewer.
How distributions are taxed | - Distributions are taxed as ordinary income.*
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| - A 25% penalty may apply to taxable distributions taken before age 59½ if you withdraw funds within two years from the date you first participated in the SIMPLE IRA (exceptions apply).
- A 10% penalty may apply to taxable distributions taken before age 59½ if you have participated in the SIMPLE IRA for more than two years.
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*Roth SIMPLE/SEP IRAs are permitted but most providers do not yet offer them.
SEP IRAs
A SEP IRA (Simplified Employee Pension) is a retirement account for anyone who is self-employed, owns a business, or earns freelance income.
How distributions are taxed | - Distributions of pretax contributions and earnings are taxed as ordinary income.
- Distributions of after-tax contributions are not subject to ordinary income tax.
- If both pre- and after-tax contributions have been made, distributions are taken from both proportionally.
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| - A 10% penalty may apply to taxable distributions made prior to age 59½ (though certain exceptions apply).
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Traditional 401(k) and 403(b) plans
These tax-deferred employer-sponsored retirement accounts are one of the most common ways workers save for retirement.
How distributions are taxed | - Distributions of pretax contributions and earnings are taxed as ordinary income in the year distributed.
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| - A 10% penalty may apply to the taxable portion withdrawn if you are not yet age 59½ or if you have terminated from employment prior to the year you turned 55 (exceptions apply).
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| If you are not a 5% or greater owner of the business, you are subject to RMDs. |
Roth 401(k) and Roth 403(b) plans
These accounts are similar to traditional 401(k) plans with one important difference: Contributions to a Roth account are taken from your pay after income taxes have been deducted.
How distributions are taxed | - Distributions of contributions and conversion assets are always income-tax free.
- Qualified distributions of earnings are also tax-free.
- Non-qualified distributions of earnings are taxed as ordinary income.
- Non-qualified distributions are pro-rata amounts of contributions, conversions and earnings.
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| - A 10% penalty may apply to distributions of assets converted to a Roth 401(k) made within five years of conversion (and prior to age 59½), though exceptions apply.
- A 10% penalty may apply to taxable distributions of earnings prior to age 59½.
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457(b) plans
These tax-advantaged retirement savings accounts are offered to employees of certain state and local governments and tax-exempt organizations, including law enforcement officers, civil servants, and university workers.
How distributions are taxed | - Distributions are taxed as ordinary income in the year distributed.
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| - No penalty for early withdrawals, once you leave your job.
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Get help with your retirement distribution planning
Deciding how and when to take distributions from your retirement plans is an important decision. We can help you evaluate your options and decide on an approach that serves your financial goals and needs.