How IRAs Are Taxed

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How IRAs Are Taxed

The tax issues of individual retirement accounts can be complicated. We have broken them down into four categories:

Taxing of Deductible and Non-Deductible Contributions

Contributions to an IRA may be fully or partially deductible. When these contributions are withdrawn, the deductible part is fully taxed but the non-deductible part is not.

Taxes on Excess Contributions

If you contribute more than you are allowed, you are required to remove the excess. Failure to do so results in a penalty tax.

Rollovers

You are allowed to remove money from your IRA for up to 60 days before replacing it into another IRA. If you fail to return the money to the IRA within the 60-day period, you will be subject to income tax and possible penalties.

Premature Withdrawals and Insufficient Distributions

If you withdraw funds before the age of 59½, you are generally subject to a premature distribution penalty (there are certain situations that will allow you to escape the penalty). If you fail to take your required minimum distribution after reaching 73, you will be subject to a penalty.

IRA rules are rigid and designed to encourage saving for retirement but not as an estate building tool. However, many savvy investors take full advantage of the rules to defer taxes as long as possible and pass on a legacy to their heirs.