Taxation of Retirement Plan Distributions
- One of the most common types of retirement plans is the tax-deferred plan. With this plan, you make pre-tax contributions to your account, and you can then invest that money into various securities. The taxes on the earnings of the securities are deferred. Once you reach the age of 59 1/2, you can start taking out money and you will have to pay taxes on it. This type of taxation is used with the 401k, IRA, 403b, among others.
- Another type of retirement account actually offers tax-exempt earnings. With the Roth IRA and a Roth 401k, you fund your account with money that has already had taxes taken out of it. Then you invest that money into various securities like stocks and bonds. The money that you make from these securities is not taxed while it is in the account. Even after you start taking distributions at the age of 59 1/2, you do not have to worry about paying taxes on the money.
- Pensions and annuities are two other tools that are commonly used for retirement savings. With either one of these, the amount of money that you have to pay in taxes is based on how the contributions to the account were made. If your employer contributed to a pension or an annuity on your behalf, you will have to pay taxes on the full amount of your distribution. If you find it either one with after-tax money, you will only have to pay partial taxes on the distributions.
- With most retirement plans, if you take money out before you reach the age of 59 1/2, you will have to pay more money to the Internal Revenue Service. With the 401k, IRA and other similar retirement accounts, you will have to pay a 10 percent early distribution penalty. You will also have to pay taxes on the amount of money that you take out at your normal marginal tax rate. With the Roth IRA, you can actually take out the money that you have contributed without paying any penalty or taxes. If you take out earnings from the Roth IRA, you will still have to pay the 10 percent early distribution penalty.
