IRA Tax Basics

• All monies invested in an IRA account grow tax-deferred. That means that none of the taxes normally paid on investments are paid, including capital gains taxes and taxes on interest and dividends. In addition, contributions to traditional IRAs may be tax deductible for certain taxpayers. However, all money withdrawn from a traditional IRA is taxed as ordinary income. There is no tax deduction allowed for Roth IRAs; however, all withdrawals are made tax-free.
  
  

Early Distribution Taxes

• IRA distributions made before age 59 1/2 are considered early distributions. In most cases, early withdrawals are subject to a 10 percent federal income tax penalty. When early distributions are made, the IRA custodian may ask if you want to have taxes withheld from the distribution, however, all withholding is optional.
  
  

Optional Tax Withholding

• Whether a distribution is an early distribution or a regular distribution, an IRA custodian is required to withhold whatever amount the account owner designates for federal income taxes. Account owners can choose to have either a percentage or a flat amount withheld from all distributions. The financial institution where your account is held may also offer to withhold state taxes from the distribution. However, IRA custodians are not required to offer state income tax withholding.
  
  

401k Tax Withholding

• There is some confusion regarding IRA income tax withholding because unlike IRA accounts, 401k plan accounts do require that money be withheld for federal income taxes. Withdrawals from 401k accounts are generally subject to a mandatory 20 percent withholding for federal income taxes. Like IRA accounts, the financial institution may, but is not required, to offer state income tax withholding.