There are few bigger concerns in retirement than funding it. Between 401(k)s, IRAs, pensions, and Social Security, the sources are many but equally important in molding the retirement lifestyle of your dreams.
But what happens when you’re hit with an unexpected tax bill on your IRA, restricting your ability to fulfill the lifestyle you’ve wanted? Luckily there are a few ways to reduce or avoid getting taxed on your IRA withdrawal.
A quick note on terminology: Unless it meets a few specific criteria, you are not taxed on Roth IRA withdrawals since you paid your taxes before depositing the money into the account, so we’re talking only about traditional IRAs here.
Take Advantage of Standard Deductions
If your taxable income for the year is $0, then you’re eligible for about $20,300 in withdrawals without being taxed if you’re married with no dependents ($12,400 comes from the standard deduction and $3,950 for each spouse). But this is only if your taxable income for the year is nothing: no part-time work, or money earned from businesses, etc.
Dip a Little in Several Pots
But does that mean you have to live off of $20,300 a year? Not if you have other retirement accounts. You could also take withdrawals from tax-free investments (Roth IRAs and municipal bonds) to supplement your standard deduction amount. If you planned far enough out, then you can still live off of a decent amount of money without having to pay taxes on your traditional IRA.
Donate to Charity
There are other ways to reduce the tax bill on your traditional IRA withdrawals if you don’t need the money. IRA distributions are required by the time you reach 70 1/2 years of age and if you miss one, you’re hit with a 50% tax penalty. So you’ll need to take the distributions whether you need them or not.
But what if it’s just extra money sitting around collecting figurative dust? If you have a favorite charity, you can donate up to $100,000 without having to owe income tax. The distribution will have to come directly from your IRA account – if you personally accept the distribution then donate it, that will count as income and you’ll owe taxes on it. The charity will have to be eligible in order to count as a tax break.
Covering Specific Expenses
If you have to take money out before you reach the age of 59 1/2 then the IRS will cut you a small break for early withdrawals. Although you’ll still owe income tax on these, the 10% additional penalty is waived. These expenses include large medical bills, college for yourself, spouse, or dependents, a first home, and other specific situations.
The IRS is typically stringent when it comes to taxing traditional IRAs (remember it was in a tax-deferred account). If you really want to avoid taxes in retirement and would rather pony up to the government now rather than later, then a Roth IRA might be more appropriate.
