If you take a taxable distribution from an individual retirement account, you may be subject to federal tax withholding rules. In some cases, you may also be required to withhold state taxes as well.
There are two reasons you may be subject to federal withholding: you take a taxable distribution from your IRA, or you participate in a 60-day rollover from one IRA custodian to another.
The IRS stipulates that IRA custodians automatically withhold 10 percent of taxable IRA distributions unless you fill out paperwork that instructs otherwise. This may be more or less than what you owe. Many custodians let you choose your own withholding rate.
Rollovers are subject to 20 percent withholding; but to avoid the IRS's 10 percent penalty on early withdrawals, you must deposit 100 percent of your funds into a new IRA within 60 days. In this scenario, you would have to come up with 20 percent of your rollover out-of-pocket to make the up the difference.
You can avoid the 20 percent withholding fee by initiating a direct trustee-to-trustee transfer between IRA custodians. This way, your money passes from one institution to another, but not through your hands.
Some states have withholding rules, others do not. Check with your state's department of revenue to make sure you are compliant. Your IRA custodian may also be able to fill you in on your state's withholding rate, if there is one.