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How Taxes Affect Retirement Investments

Make better account management decisions through understanding of tax status

By National Endowment for Financial Education

Income taxes and estate taxes are different for your various retirement investments.

If you understand the tax status of your investments, you can make better decisions about when and how much you withdraw from various accounts.

Retirement Accounts and Income Taxes

At any age, money you take out of an employer retirement plan, such as a 401(k) or a 403(b), or a non-Roth IRA, is subject to ordinary income tax, just like stock dividends or CD interest. A few notes about this:

  •     At age 59½, you can start withdrawing from these retirement plans with no penalty. All you have to worry about is paying income tax on your retirement withdrawals. If you withdraw before 59½, you may be subject to a 10 percent early withdrawal penalty.
  •     You can control how much or how little you withdraw every year, up until age 70. By controlling how much you withdraw, you can control the amount of income taxes you owe.
  •     Once you reach age 70, you must begin taking “required minimum distributions” each year from most employer plans and non-Roth IRAs. The IRS requires that you take out a certain amount—calculated by the employer plan or IRA provider—each year, based on your age. You must be careful to withdraw at least your annual withdrawal amount, because if you take less, there is a 50 percent penalty on the difference between what you actually take out and what you should take out.

Roth IRAs and Income Taxes

Money withdrawn from a Roth IRA is treated differently:

  •     Assuming you are past age 59½ and have owned a Roth IRA for five or more years, any money—principal and earnings—you take out is income tax free! (If you are under age 59½, you can always take out principal contributions without tax or penalty, but not any earnings.)
  •     As the original owner of the Roth IRA, you do not have to start taking withdrawals at age 70.
  •     You never have to take money out of your Roth IRA. You can leave it all for your beneficiaries, whether you live to 80 or 90 or beyond.

Retirement Accounts, Roth IRAs, and Estate Taxes

Estate taxes can impact retirement accounts. All forms of retirement accounts (employer plans, traditional IRAs, and Roth IRAs) will be included in your estate and may be subject to estate tax. In 2012, your estate can have total assets (retirement and non-retirement) up to $5.12 million and not owe any federal estate tax. Estate tax rates are currently higher than ordinary income tax rates. Therefore, if you keep the total value of your estate under the current year’s dollar limit, you can save your heirs significant estate-tax dollars. While you can’t do much to lower your retirement account assets without triggering income tax, an attorney or financial planner can help you find ways to shrink your non-retirement assets for estate purposes and lower potential estate taxes.

This material is provided by, a site from the National Endowment for Financial Education that helps people explore all of their retirement decisions.

National Endowment for Financial Education
By National Endowment for Financial Education
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