Yes, most IRA withdrawals get taxed as ordinary income. When you pull money from your IRA, the IRS treats it like money you earned from work. This means you pay the same tax rate as you would on your salary. The amount you withdraw could push you into a higher tax bracket, which means you pay more taxes overall. About 60% of people age 65 and older receive some income from IRAs, making this one of the most important tax situations for retirees.
Here’s what you’ll learn in this article:
📌 Why the IRS taxes IRA withdrawals as ordinary income instead of as investment gains
📌 The difference between Traditional IRAs and Roth IRAs and how each type gets taxed when you withdraw money
📌 How early withdrawal penalties work and which exceptions let you avoid the 10% penalty
📌 Which strategies help you withdraw money with the smallest tax bill possible
📌 Common mistakes people make that cost them thousands of dollars in extra taxes
Why Your IRA Withdrawals Get Taxed as Ordinary Income
The federal tax code treats IRA withdrawals differently than investment profits. When you contribute money to a Traditional IRA, you often get a tax deduction, which means you don’t pay income tax on that money when you put it in. The IRS lets that money grow without taxes for years or decades.
When you finally withdraw that money, the IRS collects the taxes you avoided when you made the contribution. This is why virtually every penny you take out of a Traditional IRA becomes taxable income in the year you withdraw it. The tax rate stays the same as it would be on your regular paycheck—it goes by your tax bracket, not a special rate for retirement savings.
The reason for this system is simple: the government wanted to help you save for retirement by letting you skip taxes now. In exchange, you accept that you’ll pay taxes later when you actually use the money. The IRS calls this a “tax-deferred” savings account because you’re postponing taxes, not avoiding them forever.
Traditional IRAs vs. Roth IRAs: Two Different Tax Paths
A Traditional IRA and a Roth IRA follow opposite tax rules. In a Traditional IRA, you may deduct your contributions from your income now, which lowers your taxes today. You don’t pay taxes on the growth inside the account either. Then you pay taxes on everything when you withdraw it.
With a Roth IRA, you cannot deduct your contributions. You pay taxes on that money in the year you contribute it. But here’s the reward: the money grows tax-free inside the account, and when you withdraw it in retirement, you owe zero taxes on it—assuming you follow the rules.
This creates a fundamental choice: pay taxes now (Roth) or pay taxes later (Traditional). The right choice depends on whether you think your tax rate will be higher or lower in retirement. If you expect to earn less money in retirement, a Traditional IRA saves you money because you’ll pay a lower tax rate on withdrawal than on your current income.
| Traditional IRA | Roth IRA |
|---|---|
| Tax deduction when you contribute | No tax deduction when you contribute |
| Tax-free growth inside the account | Tax-free growth inside the account |
| Pay income taxes on all withdrawals | Withdrawals are tax-free in retirement |
| Must start withdrawals at age 73 | No required withdrawals during your lifetime |
SEP IRAs and SIMPLE IRAs: Business Owner Rules
If you own a business, you might use a SEP IRA (Simplified Employee Pension) or a SIMPLE IRA instead. These accounts work like Traditional IRAs for tax purposes, but they allow larger contributions because they’re designed for self-employed people and small business owners.
When you withdraw money from a SEP IRA, the same rule applies: it’s taxed as ordinary income. The full amount you take out gets added to your other income for the year, and you pay taxes at your normal rate. The only difference is that you can contribute much more to a SEP IRA than a regular Traditional IRA—up to 25% of your business income or $69,000 in 2024.
A SIMPLE IRA works the same way for taxation. Money goes in before taxes, grows without taxes, and becomes fully taxable when you withdraw it. The contribution limits are smaller than SEP IRAs but bigger than regular IRAs, with a maximum of $16,000 in 2024 if you’re under 50 years old.
The Ordinary Income Tax Rate Explained
Ordinary income means the tax you pay on it matches the regular income tax brackets everyone uses. If you earn $50,000 from your job and withdraw $20,000 from your IRA, the IRS treats it as if you earned $70,000 that year. Your withdrawal gets added right on top of your other income.
This matters because it could push you into a higher tax bracket. If your normal income already puts you at the 22% tax bracket, an extra $20,000 in withdrawals might push some of that money into the 24% bracket. You’ll pay more tax on that portion because of the withdrawal.
Unlike long-term capital gains (which get taxed at lower rates), IRA withdrawals don’t get special treatment. Long-term capital gains can be taxed at 0%, 15%, or 20% depending on your income. But IRA withdrawals stay at your regular tax rate, whether that’s 10%, 12%, 22%, 24%, 32%, 35%, or 37%.
Why You Can’t Avoid This Tax in Most Situations
The IRS built the IRA system with a clear deal: you get tax breaks now, so you must pay taxes later. If the government let you avoid taxes on withdrawals, the whole point of the tax deduction disappears. The government wouldn’t collect the taxes it gave up when you made the contribution.
Once you choose to contribute to a Traditional IRA with a tax deduction, withdrawal taxes become nearly unavoidable. The only exceptions involve specific situations like disability or certain hardships. Even then, you still owe income tax on the withdrawal—you just might avoid the 10% penalty fee.
This is why people sometimes get surprised by their tax bill in retirement. They spent decades getting tax deductions and forgot they’d have to pay it all back when they retired and started taking money out.
Understanding the 10% Early Withdrawal Penalty
If you withdraw money from a Traditional IRA before age 59½, the IRS adds a 10% penalty on top of the regular income tax. This penalty is separate from your regular income tax. If you withdraw $10,000 at age 55, you owe 10% penalty ($1,000) plus your normal income tax on the full $10,000.
The penalty exists to discourage people from raiding their retirement savings early. The government wants that money to stay invested until you actually retire. However, Congress created several exceptions where you can withdraw early without the penalty.
You still owe regular income tax on the withdrawal, but you escape the extra 10% penalty. This makes a huge difference. A 10% penalty on a $50,000 withdrawal adds $5,000 in costs on top of your regular taxes.
The Exceptions That Eliminate the 10% Penalty
Exception 1: Age 59½ or Older
Once you reach age 59½, the 10% penalty disappears completely. You still owe regular income tax, but there’s no extra penalty. This is the main reason people wait until this age to start large IRA withdrawals.
Exception 2: Disability
If the IRS determines you’re disabled, you can withdraw any amount without the 10% penalty. The IRS has a specific definition of disability: you cannot engage in any substantial work because of a physical or mental condition, and the condition must last 12 months or longer or result in death. You still pay income tax on the withdrawal, but not the penalty.
Exception 3: Medical Expenses
You can withdraw money penalty-free to pay medical expenses that exceed 7.5% of your adjusted gross income (AGI). This means you need big medical bills to use this exception. If your AGI is $80,000 and your medical bills are $10,000, you qualify because $10,000 exceeds 7.5% of $80,000 ($6,000).
Exception 4: Health Insurance for Unemployed
If you lose your job and need to pay for health insurance, you can withdraw without the penalty. This exception only applies while you’re unemployed and paying for your own health insurance premiums.
Exception 5: First-Time Home Buyer
You can withdraw up to $10,000 in your lifetime to buy your first home. This is a one-time exception, so use it wisely. You still owe income tax, but not the penalty.
Exception 6: Education Expenses
Withdrawals to pay for higher education expenses (tuition, fees, books, room and board) avoid the 10% penalty. The student can be yourself, your spouse, a child, or a grandchild. Income tax still applies.
Exception 7: Substantially Equal Periodic Payments
This is a complex exception called SEPP or “Rule 72(t)”. If you take payments based on your life expectancy, you can start withdrawals before 59½ without the penalty. However, you must follow strict rules about payment amounts and cannot change them for five years or until age 59½—whichever comes later.
How Roth IRA Withdrawals Get Taxed Differently
Roth contributions come out tax-free at any time. Since you already paid taxes on the money when you contributed it, the IRS doesn’t tax the contribution again. This is a huge advantage of Roth IRAs over Traditional IRAs.
The earnings (investment growth) inside a Roth IRA face different rules. If you’ve owned the Roth for at least five years and you’re age 59½ or older, earnings come out tax-free too. This five-year rule applies separately to each Roth conversion—it’s called the “five-year holding period.”
If you withdraw earnings before satisfying these requirements, the earnings face income tax plus the 10% early withdrawal penalty. The contribution part still comes out tax-free, but the growth doesn’t. This makes Roth IRAs especially powerful for long-term savers but confusing for early withdrawals.
The Five-Year Rule for Roth Conversions
A Roth conversion happens when you move money from a Traditional IRA into a Roth IRA. You pay income taxes on the converted amount, but it gets treated as a contribution to the Roth, not earnings. This creates a powerful tax planning strategy but with strict timing rules.
If you convert money from a Traditional IRA to a Roth IRA, you must wait five years before withdrawing that converted amount penalty-free. This five-year clock starts on January 1st of the year you do the conversion. If you convert in March 2024, the clock runs from January 1, 2024.
The five-year rule is separate for each conversion. If you do conversions in three different years, each one has its own five-year clock. This matters if you plan to use Roth conversions as part of your tax strategy.
| Roth IRA Component | Withdrawal Age | Holding Period | Tax on Withdrawal |
|---|---|---|---|
| Contributions | Any age | None | Tax-free |
| Earnings | 59½+ | 5 years from first contribution | Tax-free if qualified |
| Earnings | Before 59½ | Any length | Taxable + 10% penalty |
| Converted amount | 59½+ | 5 years from conversion | Tax-free |
Required Minimum Distributions: You Must Withdraw at Age 73
Starting in 2023, Required Minimum Distributions (RMDs) begin at age 73 for most Traditional IRA owners. Before 2023, it was age 72, but the law changed. You must start taking these distributions whether you need the money or not—the IRS forces you to begin withdrawing from your retirement account.
The amount you must withdraw is calculated using your account balance and your age. Generally, you divide your account balance by a life expectancy number from the IRS table. The older you are, the larger the percentage you must withdraw each year.
If you don’t take your RMD, the IRS charges a penalty of 10% of the amount you should have withdrawn (previously 50%, but that changed in 2023). If your RMD was $10,000 and you withdrew nothing, you owe a $1,000 penalty. This is on top of regular income tax on the amount you should have withdrawn.
Roth IRAs are different—there are no RMDs during your lifetime. This is another major advantage of Roth IRAs for people who don’t need retirement income immediately. Your heirs will eventually need to withdraw the money after you pass away, but you can leave it invested for as long as you live.
Calculating Your RMD: The Three-Step Process
Step 1: Find Your Account Balance on December 31
Look at your IRA statement on December 31st of the previous year. This is your “account balance” number. If your account is worth $500,000 on December 31, 2023, use that number to calculate your 2024 RMD.
Most custodians (the company holding your IRA) provide this number on your statement. If you have multiple IRAs, you add all the balances together to get one total, then divide by the life expectancy factor. You can take the distribution from any one IRA, or several, as long as the total meets your RMD.
Step 2: Find Your Life Expectancy Factor
The IRS provides tables that match your age to a “life expectancy factor.” If you’re 73 years old, your factor might be 26.5. At 80 years old, it might be 18.7. The older you get, the smaller the factor becomes, which means you must withdraw more each year.
Most people use the “Uniform Lifetime Table” from the IRS. There’s a different table for people whose spouse is more than 10 years younger, and another for non-spouse beneficiaries. The IRS publishes these tables every year in their guides and on their website.
Step 3: Divide the Balance by the Factor
Take your account balance from Step 1 and divide it by your life expectancy factor from Step 2. If your balance is $500,000 and your factor is 26.5, your RMD is $18,868. This is the minimum you must withdraw that year.
You can withdraw more than your RMD without penalty, but not less. If you withdraw $25,000 when your RMD is $18,868, that’s fine. If you withdraw only $15,000, you face a 10% penalty on the $3,868 shortfall, which costs $387 in penalty.
State Income Tax and IRAs: Not All States Are Equal
Federal income tax applies everywhere, but state income tax varies wildly. Some states don’t tax IRA withdrawals at all. Others tax them exactly like the federal government does.
States with no income tax include Florida, Texas, Wyoming, South Dakota, Washington, Nevada, Tennessee, and New Hampshire (though New Hampshire taxes only dividend and interest income, not IRA withdrawals). If you live in any of these states, you escape state income tax on IRA withdrawals—a major advantage over high-tax states.
High-tax states like California, New York, and Massachusetts tax IRA withdrawals as ordinary income, just like the federal government. Your withdrawal gets added to your other income, and you pay state tax on the full total. Some of these states offer special treatment for retirement income, but it varies.
A few states tax some IRA withdrawals at a lower rate or exclude certain amounts. Colorado excludes up to $24,000 of retirement income for residents age 55 and older. Missouri excludes military pension income but not IRA withdrawals. The rules are state-specific and change frequently.
If you’re considering moving in retirement, state tax treatment should factor into your decision. Moving from New York (13% top rate) to Florida (0% state income tax) could save thousands of dollars annually. However, you must establish residency properly—simply owning property doesn’t make you a resident for tax purposes.
The Three Most Common Withdrawal Scenarios
Scenario 1: Mandatory Withdrawals at Age 73 With Income Tax Surprise
Sarah is 73 years old with a $400,000 Traditional IRA. She has Social Security of $30,000 per year and a pension of $40,000 per year. She doesn’t need the IRA money yet because her pension covers her expenses, but she must take her RMD.
Using the IRS table, Sarah’s life expectancy factor is 26.5. She must withdraw $15,094 ($400,000 ÷ 26.5). This withdrawal gets added to her $70,000 in other income ($30,000 + $40,000), pushing her total income to $85,094.
The problem: Social Security taxation kicks in. When your combined income (50% of Social Security plus all other income) exceeds certain amounts, up to 85% of your Social Security becomes taxable. Sarah now owes federal income tax on part of her Social Security that wasn’t taxable before, even though she didn’t do anything wrong.
| Income Event | Amount | Tax Result |
|---|---|---|
| Pension + Social Security | $70,000 | $30,000 Social Security stays mostly tax-free |
| RMD withdrawal added | +$15,094 | Up to 85% of Social Security becomes taxable |
| New total income | $85,094 | Unexpected tax bill on Social Security |
Scenario 2: Early Withdrawal at Age 55 Without Penalty But With Surprise Taxes
Marcus lost his job at age 55 and needs cash to live on while he finds work. He has a $200,000 Traditional IRA and figures he can take money out without the 10% penalty because of unemployment and health insurance costs. His logic is sound for the penalty, but incomplete for taxes.
Marcus withdraws $30,000 to cover six months of living expenses and health insurance. He avoids the 10% penalty ($3,000) because of the unemployment exception. But he still owes income tax on the full $30,000.
If Marcus has no other income that year, his $30,000 withdrawal puts him in the 12% tax bracket. He owes $3,600 in federal income tax plus state income tax (if applicable). He thought he was avoiding taxes because he avoided the penalty—a critical mistake.
| Withdrawal Aspect | Amount | Tax or Fee |
|---|---|---|
| Withdrawal taken early | $30,000 | No 10% penalty (unemployment exception) |
| Income tax owed | $30,000 | $3,600 at 12% federal rate |
| State income tax (example) | $30,000 | $1,500 at 5% state rate |
| Net cash Marcus receives | $30,000 | Only $25,000 after taxes |
Scenario 3: Roth Conversion Strategy at Age 50 With Careful Five-Year Planning
Jennifer is 50 years old with $150,000 in a Traditional IRA and $50,000 in a Roth IRA. She converts $50,000 from her Traditional IRA to a Roth IRA in March 2024, knowing the five-year rule applies to converted funds.
She pays income tax on the $50,000 conversion ($9,200 if she’s in the 18.4% combined tax bracket). She accepts this tax bill because the converted money will grow tax-free inside the Roth from that point forward. Her original Roth contributions can be withdrawn anytime tax-free.
Jennifer needs cash before age 59½. If she takes money from her Roth IRA before January 1, 2029 (five years after her conversion), she must pull from her original contributions first (which are always tax-free). If she needs more than her contribution amount, the extra comes from the converted funds, which creates tax problems.
| Timeline Event | Action | Tax Consequence |
|---|---|---|
| March 2024: Conversion | Convert $50,000 from Traditional to Roth | Pay income tax on $50,000 immediately |
| 2024-2028: Five-year period | Money grows inside Roth tax-free | No taxes during growth |
| Age 55 before 2029: Early need | Withdraw from contributions first | Contributions withdraw tax-free |
| After January 2029: Age 55+ | Can withdraw converted amount | Converted amount comes out tax-free |
Form 1099-R: The Reporting Document You Must Understand
Every IRA withdrawal gets reported to the IRS on a Form 1099-R. Your IRA custodian (the company holding your IRA) sends this form to you and the IRS. This form contains critical information about your withdrawal, including the total amount, any taxes withheld, and the reason code for the withdrawal.
The IRS uses Form 1099-R to match your reported withdrawal against their records. If the form says you withdrew $25,000 but you reported $20,000 on your tax return, the IRS will catch the discrepancy. This triggers an audit letter asking you to explain the difference.
You receive Form 1099-R by January 31st following the year of withdrawal. If your custodian loses it or sends it late, contact them immediately. You need this form to accurately complete your tax return, and you need the matching copy that goes to the IRS.
The form includes a code that describes the withdrawal reason. Code 1 means an early withdrawal (before 59½) with no exception. Code 2 means an early withdrawal with an exception (so no penalty). Code 7 means a normal distribution after 59½. Different codes tell the IRS different things about your withdrawal.
Box 2a and Box 2b: Federal Income Tax Withholding Confusion
Box 2a on Form 1099-R shows the total amount withdrawn. This is the gross amount before any taxes or fees. Box 2b shows how much federal income tax was withheld from your withdrawal. These are two different numbers that confuse many people.
If you withdrew $25,000 and had $5,000 withheld for federal income taxes, Box 2a shows $25,000 and Box 2b shows $5,000. You received only $20,000 in cash, but you owe taxes on the full $25,000. The $5,000 withheld is credited against your tax bill, but it might not be enough.
The IRS allows IRA custodians to withhold federal income tax, but they use a standard formula that might not match your actual tax rate. If you’re in a higher tax bracket than the withholding assumes, you’ll owe additional taxes. If you’re in a lower bracket, you might get a refund.
Box 2c shows whether the distribution is taxable. For Traditional IRAs, this box usually shows “Yes.” For Roth IRAs with qualified withdrawals, this shows “No.” This box tells the IRS whether they should expect you to report tax on this distribution.
Box 7: The Reason Code That Changes Everything
The reason code in Box 7 of Form 1099-R changes how the IRS treats your withdrawal and whether the 10% penalty applies. Code 1 means early withdrawal with no exception—the 10% penalty applies. Code 2 means early withdrawal with a qualifying exception—no penalty. Code 7 means normal distribution—no penalty.
If your custodian enters the wrong code, you might pay penalty tax you shouldn’t owe, or the IRS might think you owe penalty when you don’t. You need to verify this code before filing your tax return. If it’s wrong, contact your custodian and request a corrected Form 1099-R.
Some custodians make mistakes with reason codes, especially with exceptions like disability or education expenses. The burden falls on you to catch the error and fix it. If you filed a tax return with the wrong code, you can file an amended return after correcting it.
Form 5329: Calculating the 10% Penalty When You Owe It
If you took an early withdrawal and don’t qualify for an exception, you file Form 5329 with your tax return. This form calculates the 10% early withdrawal penalty that goes on top of your regular income tax. The penalty tax goes to Box 4 of Form 5329 and then to your main tax return.
Form 5329 has multiple parts for different types of early distributions. Part I covers IRAs. You enter the amount of the early distribution that’s subject to penalty and calculate 10% of that amount. If you withdrew $40,000 early with no exception, the penalty is $4,000.
But here’s where it gets complicated: you can claim an exception on Form 5329 even if your custodian didn’t mark it correctly on Form 1099-R. If your custodian filed Code 1 (no exception) but you qualify for the disability exception, you can file Form 5329 claiming the exception anyway. You must provide documentation if the IRS asks questions.
Lines 1 and 2 of Form 5329 Part I ask whether you had an early distribution during the year. Line 3 asks whether any amount was a qualifying exception. If you mark “Yes” to Line 3, you enter the exception amount. The penalty only applies to distributions not covered by an exception.
Form 8606: Tracking Non-Deductible Contributions
If you contributed money to a Traditional IRA without claiming a tax deduction (called a “non-deductible contribution”), you file Form 8606 to track it. This form tells the IRS that you already paid taxes on part of your IRA balance, so those dollars don’t get taxed again on withdrawal.
Non-deductible contributions occur when your income exceeds the limit for a Traditional IRA deduction, or you have a 401(k) at work. You can still contribute to a Traditional IRA, but you don’t get the tax break. Those dollars are your basis—they come out tax-free when you withdraw them.
The problem: if you have both deductible and non-deductible contributions in your IRA, and you take a withdrawal, you can’t cherry-pick which money comes out. The IRS uses a pro-rata calculation that treats all your Traditional IRA money as one big pool. A percentage of your withdrawal is taxable (from the deductible contributions) and a percentage is tax-free (from the non-deductible contributions).
This creates a serious tax trap called the “pro-rata rule.” If you have $100,000 in Traditional IRAs ($80,000 from deductible contributions and $20,000 from non-deductible contributions), and you withdraw $50,000, only $10,000 is tax-free. The $80,000 deductible portion makes up 80% of your total, so 80% of your $50,000 withdrawal is taxable.
The Pro-Rata Rule: Why You Can’t Hide Non-Deductible Contributions
The pro-rata rule treats all your Traditional IRAs as one account for tax purposes, even if they’re with different custodians. This rule prevents people from leaving non-deductible contributions in one IRA while withdrawing from another IRA with deductible contributions.
Here’s how it works: add up all your Traditional IRA balances on December 31st of the year you take the withdrawal. Calculate what percentage is non-deductible (basis) and what percentage is deductible. Apply that same percentage to every withdrawal you take that year from any Traditional IRA.
The pro-rata rule applies to all Traditional IRAs combined but not to SEP IRAs, SIMPLE IRAs, or other retirement accounts. If you have a Traditional IRA and a SEP IRA, they’re calculated separately. Only Traditional IRA balances get combined together.
This rule creates problems for people planning conversions from Traditional to Roth IRAs. If you have non-deductible contributions, converting $10,000 to a Roth might trigger taxes on $8,000 of that conversion (using the pro-rata calculation). The full $10,000 appears to be converted, but $8,000 is considered taxable income in the conversion year.
| Account Type | How Pro-Rata Rule Applies |
|---|---|
| Traditional IRA + Traditional IRA | Combined into one pro-rata calculation |
| Traditional IRA + SEP IRA | Calculated separately for each type |
| Traditional IRA + SIMPLE IRA (after 2 years) | Calculated separately |
| Traditional IRA + 401(k) | The 401(k) is not included in pro-rata calculation |
Medicare Premiums: The Hidden Tax on Higher Income
Taking IRA withdrawals can raise your Modified Adjusted Gross Income (MAGI), which affects Medicare premiums. People age 65 and older on Medicare pay premiums based on income thresholds. If your income exceeds certain amounts, you pay higher premiums—a “Income-Related Monthly Adjustment Amount” or IRMAA.
In 2024, if your MAGI exceeds $97,000 as a single filer or $194,000 as a married couple filing jointly, you pay extra Medicare premiums. The premiums increase at several income thresholds, with the highest earners paying three times the normal premium. An extra $50,000 in IRA withdrawals can mean $100-$300 more per month in Medicare costs.
Your MAGI includes Traditional IRA withdrawals, pensions, Social Security (50%), and other income. Roth conversions also count toward MAGI in the conversion year. This creates a trap where people do Roth conversions to save on taxes long-term but pay extra Medicare premiums in the short-term.
The income thresholds are adjusted yearly for inflation. Financial planners call this the “MAGI sweet spot“—the income level where you take withdrawals without triggering higher Medicare premiums. For someone on Medicare, this might mean taking exactly $97,000 in income and no more.
The Net Investment Income Tax: An Additional 3.8% Tax on High Income
If your Modified Adjusted Gross Income exceeds certain thresholds, you owe an additional Net Investment Income Tax (NIIT) of 3.8%. This tax applies in addition to regular income tax. It only affects people with substantial investment income.
In 2024, the NIIT kicks in when your MAGI exceeds $200,000 for single filers or $250,000 for married couples filing jointly. While IRA withdrawals typically aren’t considered “investment income” for NIIT purposes, conversions and other transactions can trigger it. Also, if you have other investment income, your total can cross the threshold.
The 3.8% tax is calculated on the lesser of your net investment income or the excess of your MAGI over the threshold amount. If your MAGI is $220,000 (single), the excess is $20,000, and the tax is $760 (3.8% of $20,000). This adds up fast for people with multiple income sources.
State-Specific Deductions and Exclusions for Retirement Income
Colorado excludes up to $24,000 of retirement income for residents age 55 and older. This means IRA withdrawals, pensions, and other retirement income don’t get taxed, up to that limit. Someone pulling $25,000 from an IRA pays tax on only $1,000.
Pennsylvania excludes all retirement income (including IRA withdrawals, pensions, and annuities) from state income tax. Residents can withdraw unlimited amounts from IRAs without paying Pennsylvania state income tax, though they still pay federal taxes.
Illinois excludes retirement income for residents age 61 and older. Withdrawals from IRAs, pensions, and similar accounts don’t count as taxable state income. This is a major benefit for retirees choosing to live in Illinois.
Texas, Florida, Nevada, South Dakota, Tennessee, Washington, and Wyoming have no state income tax at all. This means zero state tax on IRA withdrawals for residents, regardless of age or income. People in high-tax states often move to these states in retirement to save on taxes.
Missouri excludes military pension income but not IRA withdrawals. Some state bonds are exempt, but regular IRAs face full state income tax. The rules don’t favor IRA withdrawals specifically.
New York and California have high state income tax on IRA withdrawals (up to 13.3% in California). These high-tax states are reasons people leave in retirement. However, establishing residency in a new state requires more than owning property—you must intent to stay permanently.
Avoiding Mistakes That Cost Thousands in Extra Taxes
Mistake 1: Forgetting About the Pro-Rata Rule on Roth Conversions
People often do Roth conversions without realizing that existing non-deductible contributions in their Traditional IRA trigger pro-rata taxation. Someone converts $20,000 from Traditional to Roth thinking they’ll pay tax on $20,000. But if they have $100,000 total in Traditional IRAs with 30% basis (non-deductible contributions), they owe tax on $14,000 of the conversion ($20,000 × 70%).
The solution: calculate your basis first using Form 8606 from prior years. If you have substantial basis (non-deductible contributions), either aggregate all IRAs into one Roth conversion (to minimize pro-rata impact) or consider a backdoor Roth with a pro-rata recharacterization strategy. This requires professional help but saves money.
Mistake 2: Taking RMDs From the Wrong Account
You have multiple IRAs—a Traditional IRA, a SEP IRA, and a Roth IRA. Your RMD applies to Traditional and SEP IRAs combined, not the Roth. If your RMD is $15,000, you can take it from your Traditional IRA, your SEP IRA, or both combined. But if you accidentally take it only from your Roth, you’ve still failed to take your RMD from the accounts that require it.
The consequence: a 10% penalty on the RMD you didn’t take. If your RMD was $15,000 and you took nothing from your Traditional/SEP accounts, you owe $1,500 in penalty plus income tax on the amount you should have withdrawn.
Mistake 3: Withdrawing Too Much and Pushing Into a Higher Tax Bracket
You plan to withdraw $40,000 from your IRA to fund your year. You don’t realize that this $40,000 gets added to your other income. If you already have $50,000 in income from Social Security and pensions, your total becomes $90,000. This higher total might push you from 12% tax bracket into 22%, creating much higher taxes.
A careful calculation before the withdrawal could have shown you that withdrawing $35,000 keeps you in the 12% bracket. The difference between $40,000 and $35,000 in withdrawal is $5,000, but the tax difference is much larger because of the bracket change.
Mistake 4: Not Understanding Social Security Taxation Combined With IRA Withdrawals
Your Social Security is mostly tax-free if your combined income (50% of Social Security plus all other income) stays below $25,000 (single) or $32,000 (married). But an IRA withdrawal pushes your combined income higher, potentially making 85% of your Social Security taxable.
Someone getting $25,000 Social Security with no other income pays no tax on it. But add a $20,000 IRA withdrawal, and suddenly $12,000-$17,000 of the Social Security becomes taxable (depending on exact calculations). The IRA withdrawal created taxes on income that wasn’t taxed before.
Mistake 5: Missing Form 1099-R Corrections for Wrong Reason Codes
Your custodian files Form 1099-R with Code 1 (early withdrawal, no exception) when you qualified for the disability exception. You file your taxes accepting the code and pay the 10% penalty. Later you realize the mistake—you shouldn’t have paid the penalty.
You can fix this with an amended tax return, but only if you act fast. If three years pass, the statute of limitations might prevent you from getting a refund. Contact your custodian immediately if Form 1099-R shows a wrong reason code. Request a corrected Form 1099-R (marked “corrected”) before filing your tax return.
Mistake 6: Forgetting About IRMAA Medicare Premium Increases
You do a $50,000 Roth conversion to save taxes long-term but don’t realize it will increase your Medicare premiums. Your income crosses the IRMAA threshold, and your Medicare Part B premiums jump from $164/month to $344/month—an extra $2,160 per year. This hidden cost wipes out half the tax savings you thought you’d achieve.
Calculate MAGI impact before large conversions or withdrawals. Sometimes taking the withdrawal over two years keeps you below IRMAA thresholds both years, saving more money overall.
Do’s and Don’ts to Maximize Tax Efficiency
| DO | WHY |
|---|---|
| Calculate pro-rata ratio before converting to Roth | Prevents surprise taxes on conversions; might reveal that some strategies make no sense |
| Check Form 1099-R for correct reason code before filing | Wrong codes trigger unnecessary 10% penalties; corrections are simple if you catch them early |
| Plan withdrawals to stay within tax brackets | Keeping income lower means lower tax rate; even $1,000 difference in bracket = $100+ in extra taxes |
| Coordinate IRA withdrawals with RMDs | Satisfying RMD with planned withdrawal prevents 10% penalty and keeps income planning on track |
| Monitor Social Security taxation thresholds | Combined income drives taxation of Social Security; $1 more income can make $1.85 of Social Security taxable (85% inclusion) |
| Establish residency before moving for tax benefits | Moving states for tax benefits requires intent to stay, not just buying property; IRS scrutinizes “domicile” |
| Use Form 8606 to track non-deductible contributions | Basis tracking ensures you don’t pay tax twice on same money; required for pro-rata calculations |
| DON’T | WHY |
|---|---|
| Assume avoiding the 10% penalty means no taxes | Penalty and income tax are separate; avoiding penalty doesn’t help with regular tax bill |
| Take all RMDs from one IRA without checking totals | If you have multiple IRAs, the RMD can come from any or all of them; taking from the wrong one means you miss the RMD |
| Withdraw from Roth before five years for converted funds | Converted funds have separate five-year rules; early withdrawal creates unexpected taxes and penalties |
| Make IRA withdrawals without calculating MAGI impact | Combined income affects Medicare premiums, Social Security taxation, and investment income thresholds |
| Trust custodian reason codes without verification | Custodians make mistakes; you’re responsible if Form 1099-R shows wrong code and you don’t correct it |
| Forget about state income tax when moving | Some states tax IRA withdrawals heavily; others exclude retirement income; this changes your real after-tax income significantly |
| File tax return without Form 1099-R in hand | You need the matching copy showing what custodian reported to IRS; discrepancies trigger audit letters |
Pros and Cons of Different Withdrawal Strategies
| Withdrawal Strategy | PROS | CONS |
|---|---|---|
| Taking RMD at minimum level | Keeps income low; reduces tax bracket impact; preserves compounding growth | Must take it every year; creates mandatory taxable income |
| Roth conversion before RMDs start | Future withdrawals are tax-free; no RMD requirements on Roth; heirs inherit tax-free | Triggers current income tax bill; increases MAGI in conversion year; affects Medicare premiums temporarily |
| Withdrawal clustering (large withdrawal one year) | Can time withdrawal for low-income year; satisfies multiple-year needs at once | Pushes into higher tax bracket that year; affects Social Security taxation severely; no income next year to offset |
| Equal payments from SEPP (Rule 72(t)) | Escape 10% penalty before 59½; structured approach prevents overspending | Must follow strict payment amounts for 5 years; cannot change amounts; inflexible |
| Only taking from Roth contributions (not growth) | Tax-free withdrawals; no RMD requirements; flexibility for emergencies | Uses up your tax-free basis; won’t last as long if you need ongoing income |
| Waiting until 59½ to withdraw | No 10% penalty on any amount; all withdrawal is regular income tax only | Missing money when needed; must follow RMDs starting at 73; less flexibility before 59½ |
IRA Withdrawals and Divorce: Splitting IRAs Without Penalty or Taxes
When a court orders an Qualified Domestic Relations Order (QDRO), an ex-spouse can receive a portion of your IRA as part of divorce settlement. This split doesn’t trigger the 10% early withdrawal penalty or income taxes for either spouse, as long as it follows specific rules.
The IRA must be split into separate accounts or separate portions within the same account. The portion going to the ex-spouse stays in an IRA (not converted to cash). At that point, it becomes their separate IRA, and they can manage it as they wish.
If the IRA is split incorrectly (like cashing out the ex-spouse’s portion and giving them cash), both spouses face income tax and potentially the 10% penalty. The receiving spouse gets stuck with a huge tax bill even though they didn’t choose to take the withdrawal early.
A QDRO must be drafted by the divorce attorney and approved by the court. The IRA custodian then processes the split. This is technical and requires precision—mistakes cost thousands in penalties and taxes.
Inherited IRAs: What Heirs Must Know About Taxes
When you inherit someone’s IRA, the tax treatment depends on whether it’s Traditional or Roth and who inherited it. Surviving spouses have the most options—they can roll the inherited IRA into their own IRA and delay withdrawals. Non-spouse beneficiaries cannot do this.
Non-spouse beneficiaries must take distributions from an inherited IRA. The new rule (starting in 2024) requires most non-spouse beneficiaries to empty the inherited IRA within 10 years. The amount withdrawn each year is taxable income to the beneficiary.
Inherited Roth IRAs have special rules. If the original owner had the Roth for at least five years when they died, the beneficiary can withdraw contributions and earnings tax-free. If the five-year rule wasn’t satisfied, earnings face income tax even though contributions don’t.
The SECURE Act (passed in 2019) changed inherited IRA rules dramatically. Most non-spouse beneficiaries lost the “stretch IRA” option where they could take tiny withdrawals over their lifetime. Now they must withdraw within 10 years, creating larger tax bills sooner.
Required Minimum Distribution Waivers: The Temporary CARES Act Relief
During the COVID-19 pandemic, the CARES Act waived Required Minimum Distributions for 2020. Retirees didn’t have to take RMDs that year, which let them avoid the $1,000 + penalty for missing RMDs. This was a one-time relief measure that won’t repeat.
Some people who didn’t take RMDs in 2020 later regretted it. They realized they could have taken the withdrawal and converted some to a Roth IRA, achieving better tax planning. However, the waiver was one year only and affected everyone.
Going forward, RMDs resume as normal. There have been discussions about making RMD waivers permanent for certain situations, but nothing has changed. Plan on RMDs starting at 73 and continuing every year until the account is empty or you pass away (for Traditional IRAs).
Qualified Charitable Distributions: A Tax Benefit Few Use
If you’re age 70½ or older and make charitable donations, a Qualified Charitable Distribution (QCD) might help. A QCD lets you give money directly from your IRA to a charity without including it in taxable income. This is legal and reduces your tax bill significantly.
A QCD counts toward satisfying your RMD without creating taxable income. If your RMD is $20,000 and you give $20,000 to charity through a QCD, you’ve satisfied the RMD requirement without any taxable income. This helps people who don’t need the money but want to support charities.
The charity must be a qualified organization (most recognized nonprofits qualify). The distribution must go directly from the IRA custodian to the charity—you cannot take the money personally and then give it to charity. Your custodian must process it as a QCD.
Most people don’t use QCDs because they don’t know about them. Financial advisors sometimes fail to mention this option. If you’re charitably inclined and age 70½+, ask your IRA custodian about QCD options. It’s a powerful tax planning tool.
FAQs
Q: Can I withdraw from my IRA at any age without penalty?
No. Before age 59½, early withdrawal triggers 10% penalty unless you qualify for an exception like disability, education expenses, or first-time home purchase. Income tax still applies regardless of age.
Q: Are Roth IRA withdrawals taxed?
No, not if you follow the rules. Roth contributions come out tax-free anytime. Earnings come out tax-free after age 59½ with five-year holding period met. Early withdrawal of earnings triggers income tax plus 10% penalty.
Q: What happens if I don’t take my Required Minimum Distribution?
You owe penalty. The penalty is 10% of the RMD amount you didn’t take (previously 50%, but changed in 2023). You also owe income tax on the amount that should have been withdrawn.
Q: Can I avoid taxes by having my IRA custodian withhold taxes?
No. Withholding reduces the cash you receive, but the full withdrawal still counts as taxable income. Withholding is a prepayment of taxes, not tax avoidance. You might owe more or get a refund at tax time.
Q: Do I pay taxes on a Roth conversion?
Yes. You pay income tax on the converted amount in the year of conversion. This is the trade-off for future tax-free withdrawals. The converted amount then has a five-year holding period before withdrawal without penalty.
Q: Does my IRA withdrawal affect my Social Security taxes?
Yes. Combined income (including IRA withdrawals) determines how much Social Security is taxable. IRA withdrawals can push income high enough to make 85% of Social Security taxable, creating unexpected taxes on Social Security that was tax-free before.
Q: What’s the pro-rata rule and why does it matter?
The pro-rata rule treats all Traditional IRAs as one account for tax purposes. If you have non-deductible contributions mixed in, a fixed percentage of every withdrawal is taxable, including Roth conversions. This creates taxes on Roth conversions many people don’t expect.
Q: Can I take distributions from my IRA before I retire?
Yes, but penalties and taxes apply unless you qualify for exceptions. Early distributions face 10% penalty plus income tax. Better options include loans from 401(k)s (if available) or other savings accounts to preserve retirement funds.
Q: Are IRA withdrawals counted as income for Medicare premium purposes?
Yes. IRA withdrawals increase your Modified Adjusted Gross Income, which affects Medicare premiums if income exceeds thresholds. High income means higher premiums—up to three times normal amount. Plan withdrawals carefully if on Medicare.
Q: Can I split my IRA with my ex-spouse without taxes?
Yes, if done through a Qualified Domestic Relations Order (QDRO). The split creates separate IRAs with no penalty or tax. If split incorrectly (like cash distribution), both parties face income tax and potentially 10% penalty on the amount.
Q: What Form do I need if I took an early IRA withdrawal and don’t qualify for an exception?
File Form 5329 with your tax return. This form calculates the 10% early withdrawal penalty. You enter the distribution amount subject to penalty and calculate 10%. The penalty adds to your income tax bill.
Q: Do I have to file Form 1099-R with my tax return?
You don’t file it, but you must report the information from Form 1099-R on your tax return. Your custodian sends it to the IRS too. Discrepancies between your report and the custodian’s report trigger IRS audit letters.
Q: Can I recharacterize an IRA contribution or conversion to undo it?
No. The IRS eliminated recharacterization for Roth conversions after 2017. You can still recharacterize failed Roth conversions in certain situations, but this is limited. Consult a tax professional before converting.
Q: What’s the deadline to take my Required Minimum Distribution each year?
December 31 of the year it’s due. First RMD is due by April 1 following the year you turn 73. Missing this deadline triggers 10% penalty. Pro tip: Take RMD by December 31 and avoid penalties, even on first year.
Q: If I inherit an IRA from someone other than my spouse, must I withdraw it all immediately?
No, but within 10 years. Most non-spouse beneficiaries must empty the inherited IRA by December 31 of the tenth year following the owner’s death. You can take it all at once or spread it out, but it must be gone by the 10-year deadline.
Q: Can I avoid the pro-rata rule by keeping Traditional and Roth IRAs completely separate?
No. The pro-rata rule combines all Traditional IRAs regardless of custodian or account separation. However, it doesn’t combine SEP IRAs, SIMPLE IRAs, or 401(k)s—only Traditional IRAs are combined. If you have other types, they calculate separately.
Q: What if my custodian reports the wrong amount on Form 1099-R?
Request a corrected Form 1099-R immediately. File your tax return only after you receive the corrected form. If you filed based on wrong Form 1099-R, file an amended return after custodian corrects it. Keep documentation showing the correction.
Q: Are there any age periods where I can withdraw without penalty or taxes?
No. The only penalty-free window is after age 59½ (penalty gone, but income tax remains) or within specific exceptions (penalty gone, but income tax remains). Roth IRA contributions (not growth) can be withdrawn anytime tax-free, but conversions have five-year rules.
Related reading
- Does 401(k) Really Get Taxed at Retirement? – Avoid This Mistake + FAQs
- Are Beneficiary IRA Distributions Taxable? (w/Examples) + FAQs
- Are IRA Gains Deferred Until Withdrawal? (w/Examples) + FAQs
- Are Annuities Taxed as Ordinary Income? (w/Examples) + FAQs
- Should High Earners Contribute to a Traditional IRA?(w/Examples) + FAQs
- Are 72(t) Payments Taxed as Ordinary Income? (w/Examples) + FAQs
- How to Roll Over an Inherited IRA (w/Examples) + FAQs