When you take money out of your IRA or other retirement accounts for retirement income, you generally have to pay taxes on it. But how much in taxes should you expect to pay? There are a lot of misconceptions about tax withholdings for IRA distributions or other qualified accounts.
Let’s clarify how to calculate the necessary tax withholdings from these distributions.
Federal Tax Tables and Deductions
First, it’s important to note that everyone’s situation is unique, and tax calculations can vary. However, this high-level overview will help you understand the basics of how to determine the tax withholdings for your IRA distributions.
To start, you’ll want to look up the federal tax tables for the current year. Additionally, you should find the standard deductions. You can find them on IRS’s website on this page.
The tax tables will show the different marginal tax brackets, which determine the percentage of tax applied to different portions of your income. If you look at “married filing jointly,” from $0 to $22,000, it is taxed at 10%. So, that’s the 10% marginal bracket for 2023. From $22,0001 to $89,450 is the 12% marginal bracket and so on.
Your effective tax is the actual taxes owed divided by your gross income. Let’s look at some examples.
Example 1: Married Filing Jointly
Suppose you are married and filing jointly with a gross income of $100,000 from IRA distributions. Using the 2023 standard deduction of $27,700, you subtract this from your gross income, leaving you with a taxable income of $72,300.
Now, refer to the tax tables:
- The first $22,000 is taxed at 10%, resulting in $2,200.
- The next $50,000 is taxed at 12%, resulting in $6,036.
Adding these amounts gives you a total federal tax owed of $8,236. To find your effective tax rate, divide the total tax owed by your gross income ($8,236 / $100,000), resulting in an effective tax rate of 8.23%.
Even though the last dollar of your income is taxed at the 12% marginal bracket, your overall effective tax rate is lower because different portions of your income are taxed at different rates.
Example 2: Single Filing
Now, let’s consider a single filer with the same gross income of $100,000. The 2023 standard deduction for a single filer is $13,850, leaving a taxable income of $86,150.
According to the tax tables:
- The first $11,000 is taxed at 10%, resulting in $1,100.
- The next $33,725 is taxed at 12%, resulting in $4,047.
The remaining $41,425 is taxed at 22%, resulting in $9,113.50.
Adding these amounts gives a total federal tax owed of $16,260.50. The effective tax rate is then $16,260.50 / $100,000, which equals 16.26%. Again, despite the last dollar being taxed at a higher marginal rate, the effective rate is lower because various portions of your income fall into different tax brackets.
State Taxes
State taxes on IRA distributions vary widely. For example, Illinois does not tax IRA distributions or pension income, while other states may tax all or part of these distributions. It’s essential to check the tax laws specific to your state.
No FICA Tax on IRA Distributions
It’s also worth noting that there is no FICA tax (which covers Social Security and Medicare) on IRA distributions. This simplifies your tax calculations slightly, as you only need to focus on federal and state income taxes.
Bottom line
Calculating the appropriate tax withholdings from your IRA distributions involves understanding both your federal and state tax obligations. By using the tax tables and standard deductions, you can estimate your taxable income and determine your effective tax rate.
Always consider consulting a tax professional and/or financial adviser for personalized advice, as individual circumstances can significantly impact your tax situation.
Hopefully, this overview provides a clearer understanding of how to approach tax withholdings for IRA distributions and helps you plan accordingly for your retirement income.
Still have questions? Want a review of your specific financial situation and IRA accounts?
Schedule a free financial consultation with an Advance Capital Management adviser today.
Bill works closely with people to help them achieve their financial goals. As a financial adviser, he guides clients toward making proper decisions during all stages of their financial lives. He provides comprehensive wealth management services such as retirement planning, tax planning, investment portfolio strategies and 401(k) advice. He is a CERTIFIED FINANCIAL PLANNER™ professional and co-host of the finance YouTube channel, Under the Buttonwood Tree.
