Tax Liability on Traditional IRA Distribution

by Jane Meggitt

Contributions to traditional individual retirement accounts are tax-deferred, so withdrawals after retirement are taxed as ordinary income. Taxpayers without employer-sponsored retirement plans, such as 401ks, may deduct traditional IRA contributions on federal tax returns. Those meeting certain income limitations may also deduct all or part of the contributions, even if enrolled in an employer-sponsored retirement plan. Anyone earning income may contribute to a traditional IRA, but not everyone may deduct contributions.

Annual Contribution Limits

At the time of publication, individuals under the age of 50 may contribute a maximum of $5,000 annually to a traditional IRA, while those aged 50 and up are eligible to make an additional $1,000 catch-up contribution, for a total of $6,000. Single filers with an adjusted gross income (AGI) of $56,000 or under may take the full deduction, even if covered by an employer-sponsored retirement plan. Partial deductions may be taken by single filers with an AGI of up to $66,000. Above that amount, no deduction is permitted. Married couples filing jointly, with both spouses enrolled in an employer-sponsored retirement plan, qualify for a full deduction if their AGI is $90,000 or less. Married couples may take a partial deduction if the AGI is up to $110,000, but with higher AGIs no deduction is permitted.

Required Minimum Distributions

Traditional IRA owners may begin taking distributions at the age of 59 1/2, and mandatory withdrawals must commence by the age of 70 1/2. If IRAs do not begin taking required minimum distributions by this maximum age, or if the IRS considers the distributions too small, a 50 percent excise tax may be levied on the amount not distributed as mandated. The actual requirements for the amount of IRA distributions depend on whether the account is held by the owner or the beneficiary of an inherited IRA, as well as the age at which distributions begin. Distributions from a traditional IRA are taxed as ordinary income at the individual taxpayer's tax bracket. Most people in retirement are in a lower tax bracket than in their working years.

Early Withdrawal Tax and Penalties

Account owners making withdrawals from IRAs before reaching the minimum age are taxed not just on the amount withdrawn, but the Internal Revenue Service (IRS) levies an additional 10 percent tax penalty on these sums. If the withdrawals are made for that year's contributions before the filing due date for the federal tax return, the 10 percent additional tax does not apply.

Exceptions for Penalties

While the IRS levies a tax on all early IRA withdrawals, if the amounts are withdrawn for certain purposes, the additional 10 percent tax penalty is waived. These exceptions include using the proceeds for the purchase of a first home; higher education expenses for the taxpayer, spouse or children; and payment of medical expenses exceeding 7.5 percent of the taxpayer's adjusted gross income. Account holders becoming totally and completely disabled are also not charged the penalty for early withdrawals.