If you want to take a specific dollar amount out of your IRA, which of the following would you request your IRA custodian to distribute?
- Exact amount
- Amount plus 10%
- Amount plus 22% (or 24%, 32%, etc., based on your tax rate)
The correct answer may be any of the above depending on your tax withholding election and your state of residence. Here is what you need to know.
Withdrawals from tax-qualified retirement savings are generally considered taxable income because you have not yet paid tax on the money you put into the savings arrangement or the investment earnings accrued in the account. Because the IRS wants to make sure taxes are paid timely, and to prevent a large tax bill for you at the end of the year, trustees and custodians of retirement plan or IRA assets will withhold a certain amount of your withdrawal and send it to the IRS as a prepayment of the taxes you may owe on the amount you withdraw. If you don’t withhold enough for taxes during the year, not only will you face a hefty bill at tax time, you may have to pay under-withholding penalties as well.
IRA Withholding Rules
Because your total income tax obligation for the year is affected by many things, including marital status, tax credits and deductions, payroll tax withholding, etc., the tax rules allow you to waive federal tax withholding on your IRA withdrawal or elect an additional amount to be withheld. For instance, if you intend to roll your Traditional IRA withdrawal to another Traditional IRA within 60 days, you won’t owe taxes on that money, so you may want to waive withholding. Conversely, if you intend to keep the money you’re withdrawing from your IRA, and you expect to be in the 24% tax bracket for the year, you may want to withhold a percentage greater than the default 10% to help cover the taxes you’ll owe on the withdrawal. The withholding rate you choose is based on an estimate of how much you think you’ll owe. If you withhold too much, you can expect a refund when you file your tax return. Withhold too little, and you may owe at tax time.
Your IRA Withholding Election
Your IRA custodian will provide a withholding notice before each distribution (or once each year if you receive scheduled distributions at least quarterly.) You should review this notice before making a withholding election.
- If you don’t make a withholding election for a Traditional, SEP or SIMPLE IRA withdrawal, your IRA custodian must withhold 10% – unless you have a previous election on file. Roth IRA withdrawals are generally tax-free, so the default 10% withholding does not apply.
- If you waive withholding – No federal income tax will be withheld.
- If you elect 10% withholding – You may want to increase the dollar amount of your withdrawal by 10% if you want to walk away with a certain amount after taxes are withheld. Otherwise, for example, if you withdraw $20,000, your IRA custodian will withhold $2,000 as a prepayment of your income tax liability and you will receive a check for $18,000 (less any distribution or processing fees).
- If you request another percentage – You cannot withhold less than 10%, unless you waive withholding, but you may withhold more than 10% or a specific dollar amount. You may want to try to estimate the percentage/amount to withhold based on your anticipated tax liability.
State Income Tax Withholding
The rules for state income tax withholding are different from the federal tax rules and vary by state. Some states don’t have specific rules; others require minimum withholding amounts. Maine, for instance, requires 5.0% state tax withholding if federal income taxes are withheld, whereas state tax withholding is not required for Colorado residents. The withholding notice you receive from your IRA custodian should provide instruction on state tax withholding requirements and options.
Employer Plan Withholding Rules
The rules for federal income tax withholding on distributions from qualified retirement plans is different from the rules for IRAs.
- If you have savings in a former employer’s retirement plan, such as a 401(k) and you take a taxable distribution that is eligible to be rolled over (but is not), 20% will be withheld and remitted to the IRS before you get your check. You cannot elect out of this withholding. Any required state withholding will also be withheld.
- If you decide to roll over your employer plan savings to an IRA within 60 days of receiving the distribution check, you will be taxed on the 20% sent to the IRS unless you can come up with that dollar amount and deposit it in the IRA with the rest of the distribution.
- If you choose to roll over your savings directly from your retirement plan account to your IRA, there will be no withholding.
- If your distribution is not eligible to be rolled over (e.g., a required minimum distribution), you may elect to waive withholding or have 10% or more withheld.
For More Information
Consult your tax advisor for help determining the right amount of withholding for your situation to maximize your income and avoid surprises come tax time.
If you have any questions about making a withholding election when taking a distribution from your STRATA Trust account, please visit our FAQ section on our website, https://www.stratatrust.com/frequently-asked-questions/#distributions
 Traditional IRA withdrawals may be only partially taxable if nondeductible contributions or rollovers of any after-tax amounts were made to any of your Traditional IRAs.
 Withholding generally cannot be waived on IRA distributions delivered to a location outside the U.S.