If you are preparing to take distributions from your retirement account, you must familiarize yourself with the potential tax consequences of the various withdrawal options. Regardless of whether you take distributions monthly or once per year, the total amount you withdraw is added to your taxable earnings for the year. The frequency of your retirement account withdrawals is simply a matter of preference and convenience.
Qualified retirement accounts are those funded with pre-tax dollars, like a 401k and most individual retirement accounts. Money deposited into these accounts generates an income tax deduction for the account owner. Any growth within the account remains untaxed until it is withdrawn. Internal Revenue Service regulations limit the total amount that can be contributed into qualified accounts based on the account type and owner's annual income. In addition, withdrawals from retirement accounts generally are restricted until the owner reaches age 59 1/2.
Non-qualified retirement accounts are those funded with money you've already paid taxes on. Contributions into these accounts do not result in an income tax deduction regardless of the amount deposited. The same IRS regulations regarding restrictions on withdrawals until age 59 1/2 apply to non-qualified retirement accounts. However, no restrictions exist for the amount that you can deposit into a non-qualified account.
The Roth IRA is a unique type of retirement account that contains features and benefits of both traditionally qualified and non-qualified accounts. Roth IRAs are funded with after-tax dollars like any other non-qualified account, but contain the same restrictions regarding contribution maximums and withdrawal timelines that traditional IRAs have. However, unlike ordinary IRAs and 401k accounts, Roth IRA distributions are entirely tax-free even if they include previously untaxed growth.
Annual withdrawals from retirement accounts will increase your taxable earnings for the year. By taking a single lump-sum distribution, you may also raise your income into a higher tax bracket, thereby increasing the total taxes due. If you take an annual lump-sum withdrawal from your account, regardless of whether it's qualified or non-qualified, the account custodian may withhold up to 20 percent in anticipation of the taxes due.
Monthly withdrawals from retirement accounts will increase your taxable earnings for the year, the same as an annual lump-sum distribution. The only potential difference between taking monthly withdrawals vs. single lump sums once per year is the likelihood of the account custodian withholding 20 percent for anticipated taxes. It is less common for custodians to hold back portions of regularly scheduled monthly withdrawals.