Financial Q&A: Readers' money questions answered
Some tax basics for those about to cash out their retirement money.
Q: Are Social Security payments taxable? What about 401(k) or IRA distributions?
–B.B, via e-mail
A: They're not automatically tax-free. But Gene Utterback, a tax expert and registered financial consultant in Annapolis, Md., says their taxability depends on the other income of the recipient.
For single taxpayers, Social Security is not taxable unless their other income exceeds $25,000. For married taxpayers, the threshold is $32,000. Once income exceeds these amounts, some portion of Social Security is taxable, but never more than 85 percent.
As to 401(k) payments, Mr. Utterback says that income usually is taxable. But some of these plans allow after-tax contributions. That portion is not taxable when withdrawn. The plan administrator usually tracks these and reports total payments in Box 1 of the 1099R and taxable payments in Box 2 – the difference is the nontaxable payments.
With IRA payments, sometimes it's taxable. But it depends, says Utterback. If you're withdrawing money that you never paid tax on before, then yes, it is taxable. If you're withdrawing money that you paid tax on before you contributed it – a nondeductible IRA – then you only pay tax on the earnings.
And if you're withdrawing money from a Roth IRA, then we have to look at more details. If you've been in it for at least five years, and you're over 59-1/2 years of age, then you pay no tax on money you take out. If it's less than five years, or you're under 59-1/2, then you can remove contributions tax free, but you'll owe a tax on the earnings. You may incur a penalty to boot.
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